Taiwan Semiconductor Reaching Oversold Levels Not Seen In 2 Years

Taiwan Semiconductor (TSM) has gone through a downswing over the last three months with the stock falling over 20% in the process. This pullback has caused the weekly stochastic indicators to drop to oversold territory and their lowest reading since June 2019. The stock was trading below $40 a share back then and it would go to trade above $140 this past February. The 10-week RSI dropped below the 50-level recently and it’s the first time in a year that the indicator has been that low.

Personally, I think the selling is overdone at this point and it looks like the $179.80 area could be acting like a possible double-bottom pattern. In order for that pattern to be confirmed the stock will need to move above the high between the two lows. In this case, the high was $127.40.

Earnings and Sales Increased at a Faster Rate Last Quarter

Taiwan Semiconductor has seen earnings grow by 19% per year over the last three years while sales have increased at a rate of 13%. When the company reported first quarter results back on April 15, the company saw earnings jump 28% while sales increased by 24%. At this time the consensus estimate for Q2 earnings, due out in mid-July, reflects an expected increase of 16.7% and sales growth of 25.7%. For the year earnings are expected to increase by 16.5% and sales are expected to jump 22.3%.

With such strong growth, Taiwan Semiconductor gets some pretty strong fundamental ratings on the Tickeron Fundamental Screener. The company scores very well in the Outlook Rating, the Valuation Rating, and the Profit vs. Risk Rating.

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In addition to those high marks, Taiwan Semi has great profitability measurements. The return on equity is at 29.7% and the profit margin is 36.4%.

Sentiment is Skewed to the Bullish Side

Looking at the sentiment indicators for Taiwan Semiconductor, two of the three that I watch are pointing to greater optimism than the average stock. The only area where we see slightly more pessimism is in the options market. There are 512,152 puts open and 432,868 calls open at this time. This gives us a put/call ratio of 1.18. The average ratio falls in the 0.9 to 1.1 range, so Taiwan Semi’s isn’t too far out of line.

Analysts have quite a different opinion on the stock with 32 out of 35 analysts rating the stock as a “buy”. There are two “hold” ratings and one “sell” rating. This puts the buy percentage at 91.4% and that is well above average. The average buy percentage falls in the 65% to 75%.

Short sellers also have a pretty high opinion of Taiwan Semiconductor with a short interest ratio of 1.3. The average short interest ratio is in the 3.0 area, so this one is well below average and reflects excessive optimism. The short interest ratio jumped from 11.9 million to 15.4 million from March 31 through April 30.

With the stock now being in oversold territory, I’m not as worried about the sentiment indicators showing more optimism. When a stock is overbought and we see excessive optimism that is when I become concerned.

The Outlook for Taiwan Semiconductor

If we take all three analysis styles into account, the outlook for Taiwan Semiconductor seems to be bullish. We see solid earnings and revenue growth and great profitability measurements on the fundamental side. The Valuation Rating from Tickeron is above average and so is the Profit vs. Risk rating. On the technical side, seeing the weekly stochastic indicators moving in to oversold territory makes me think that the current selloff has run its course and there is far more potential to move higher than lower.

The sentiment indicators are a little bit of a concern, but not a huge one. Like I said above, I would be more concerned if the sentiment indicators had the same readings and the stock was in overbought territory like it was three months ago. When a company has strong fundamental indicators I expect the sentiment toward the stock to be more bullish than the average stock and that is what we have with Taiwan Semiconductor.

Based on the last few instances where the stochastic indicators reached oversold territory and then turned higher, I can see it rallying sharply over the next six months. We saw a 70% rally off of the June ’19 low and a 95% rally off of the March ’20 low. I don’t expect such a huge move this time, but I do think we could see a move in the 30% to 40% range. The one instance where the stock was oversold before those two, in Q4 2018, the stock only rallied 33% in four months.