Taiwan Semi Highlights Wacky Wall Street Ratings

 | Jul 01, 2017 | 2:00 PM EDT
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In most area of our lives we cheer when things we want to buy go "on sale." It's only on Wall Street that enthusiasm is absent when stocks are cheap, yet goes into overdrive when shares become expensive.

This week's Value Line update on Taiwan Semiconductor Manufacturing Co. (TSM) provides a good example of this phenomenon.

Value Line's timeliness system runs from 1 (best) to 5 (worst) in trying to predict year-ahead performance of share prices. Categories No. 1 and No. 2 are considered "Buys," while No. 3s are neutrally ranked. Stocks rated No. 4 or No. 5 are called "Sells."

Late last September Taiwan Semiconductor traded for just south of $30. Value Line thought it could reach $35 to $50 by 2022, generating 7% to 15% annualized total returns. Its advice? Sell @ $29.90.

Three months later, TSM barely had changed. It offered slightly better value, at $29.31, with a bit higher yield and a tad more long-term upside. Value Line stuck with its No. 4 sell rating.

By March 31 of this year, though, Taiwan Semiconductor had jumped $2.87 per share (up 9.79%) to $32.48. Afterward, TSM's projected yield was lower and its three- to five-year potential was worse. After missing a three-month move of almost 10%, Value Line changed its view from Sell to Hold.

The newest report, dated June 30 but released online on June 26, noted that Taiwan Semiconductor had surged to $36.13. The shares already were trading within Value Line's projected 2020-to-2022 range. TSM's yield was the lowest, and its price-to-earnings (P/e) multiple the highest, of those last four reports.

Logic would suggest TSM was now less attractive than it was when it was cheaper by $6 to $7 per share. Instead, Value Line cranked up its recommendation to its highest Buy rating.

Value Line's full-page reports on each stock come out only every three months. Close examination of the ratings box shows that the upgrade occurred on May 12, just as Taiwan Semiconductor was hitting about $36 for the first time ever.

Since that upgraded rating, TSM has been both higher and lower. Traders who bought on the rating change were still slightly underwater as of June 28.

Analyst ratings often go positive only after big run-ups. Few Buy ratings are issued when shares are bargain-priced. How can the average person know what they should be doing at any point in time?

Look at that same company's valuations at its previous best buying and selling opportunities. Taiwan Semiconductor's average P/E runs about 12.8 times earnings. A typical yield has been 3.44%. Big gains were always available to traders who bought at nice discounts to those levels (green-starred).

Taiwan Semiconductor's early 2015 valuation got a little big extended. People who understood that could have sold north of $25 and repurchased in the area of $17 to $18 just months later. Momentum chasers who plunged in at this year's high got the least for their money of any TSM investors in more than seven years (highest multiple plus lowest yield).

It's no wonder they haven't done well.

The June 28 valuation still appears expensive based on Taiwan Semicondudctor's historical record. Applying a normalized P/E to the firm's 2018 earnings-per-share estimate of $2.35 only would support a target price of about $30 to $31 18 months out.

Those lucky enough to own TSM from cheaper entry points should consider locking in gains. Traders thinking about getting into Taiwan Semiconductor on strength should re-think before committing new dollars.

(This commentary originally appeared on Real Money Pro. Click here to learn about this dynamic market information service for active traders.)

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