Perhaps the biggest business driving the market today is artificial intelligence (AI). Every software developer seems to be cashing in on the excitement of AI, and tech stocks are benefiting.
as S&P500 and Nasdaq Composite I’m keeping an eye on one stock in particular because it’s trading at record levels. The best part? It doesn’t appear in “The Magnificent Seven.”
shares of super micro computing (SMCI -5.42%) It has soared 5,830% in just five years. Since the start of 2024, the stock price has increased more than 300% as of market close on March 8th. Much of the momentum currently pushing up the stock revolves around the company’s latest milestone: its inclusion in the S&P 500.
This company plays an important role in the AI field. Let’s take a deeper dive into Super Micro’s business to understand why its share price has gone parabolic.
I managed to rise to the top, but…
Super Micro plays a key role at the intersection of semiconductors and artificial intelligence (AI). The company designs integrated systems for IT architecture such as storage clusters and server racks.
With the growing interest in graphics processing units (GPUs), Nvidia and Advanced Micro Devices Over the past year, Supermicro’s services have been in high demand behind the scenes.
SMCI Revenue (Quarterly) Data by YCharts.
Revenues have grown more than 100% annually, and the long-term outlook is positive with AI tailwinds. No wonder one Wall Street analyst called his Supermicro a “stealth Nvidia.”
As with all businesses, sales growth is great at the moment, but there’s more to it than sales acceleration. Now let’s look at some other elements to hone your complete investment thesis.
…some concerns remain
One of the most important things for investors to understand is that Supermicro is very much a hardware business, and its profit margins are much lower than you might think.
Gross margin for the quarter ended December 31 was 15.4%.This marked a decrease from the previous quarter and Same period last year. Management mentioned the deterioration in profit margins at the company’s financial results conference and attributed the decline to aggressive investment in new designs and market share gains.
The argument of spending for growth has its limits. Over the long term, Supermicro needs to prove that it can achieve profitable growth and steady cash flow.
Image source: Getty Images.
Valuations are drifting away from fundamentals
Considering the role of semiconductors in the AI revolution, it’s no surprise that stocks like Nvidia and AMD are gaining attention. But Supermicro’s close relationships with these chipmakers are providing some momentum. This move could come with a lot of risk, as investors may think the next he’s investing in Nvidia.
But as mentioned above, Supermicro and Nvidia are completely different businesses. At best, they are tangentially related. Some better comparisons include: hewlett packard enterprise, lenovo, Delland IBM. The company’s stock currently trades at 7x, more than twice that of IBM.
Not only is Super Micro the most expensive stock by far, but the other companies mentioned above have much more prolific businesses around the world. It’s a very specialized business, and it’s not as diverse as, say, IBM or Dell.
I think it’s an interesting way to invest in AI. The company operates under the radar, but in an important area of the AI industry.
But with low margins and widening valuations, stock price premiums appear increasingly disconnected from fundamentals. While inclusion in the S&P 500 is an admirable milestone, stock prices will soar in the short term as ETFs and passive funds that mimic the index rebalance their portfolios to incorporate new stocks into the index. Even if that’s a possibility, that alone isn’t enough of a reason to chase the stock.
For now, I’ll be sitting on the sidelines and monitoring the company’s performance. If supermicrocomputers become an influential part of the AI story over the long term, investors will have ample opportunity to buy at a more reasonable valuation.
Adam Spatacco holds a position at Nvidia. The Motley Fool has a position in and recommends Advanced Micro Devices and his Nvidia. The Motley Fool recommends International Business Machines. The Motley Fool has a disclosure policy.
