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Advanced semiconductor chips, also called graphics processing units (GPU) play an important role in the development of artificial intelligence (AI).
One thing some investors may not realize is that chip designers like Nvidia And Advanced micro devices are highly dependent on external parties for their chip distribution.
Rising chip demand has served as a bellwether for higher capital expenditures (capex) in areas such as data center infrastructure. This is true Super microcomputer (NASDAQ: SMCI)a specialist in server rack and equipment architecture, comes into play.
But despite its crucial role in the AI landscape, shares of Supermicro, as it is also known, are down just over 30% in the past three months.
Let’s take a look at what’s driving some of the selling activity and assess why now seems like a fantastic time to buy the dip in Supermicro stock.
A look under the hood
There are a few key reasons why Supermicro was sold recently.
To begin with, the macroeconomic outlook is mixed. Considering inflation, the July value of 2.9% represents the lowest level in three years. While encouraging, this is still higher than the Federal Reserve’s long-term target of 2%, and the mixed jobs numbers are making investors feel cautious. Broad market sentiment has driven selling activity in many stocks this summer.
Meanwhile, at a company-specific level, Supermicro generated $5.3 billion in revenue in the fourth quarter of 2024 (ended June 30), up 141% year over year. As you can see below, demand trends for Supermicro are strong. However, a look further down the income statement paints a different picture.
In the same quarter, gross margin decreased to 11.2%, compared to 17.0% a year ago. Operating margin also contracted by approximately 390 basis points to 6.5%. So while sales have soared since the start of last year thanks to growing interest in AI, Supermicro’s profitability has moved in the opposite direction.
In other words, rising sales and falling profitability numbers suggest the company is paying a high price for its newfound growth. A deteriorating margin profile can have negative consequences for cash flow and liquidity.
Given this inverted financial profile, I’m not surprised some investors are exiting the stock. Still, I wouldn’t press the panic button just yet.
Why the sell-off seems overdone
Management addressed the challenges surrounding the company’s margins during the last earnings call.
Essentially, the supply and demand dynamics in the AI world are currently under great pressure. This can lead to unpredictable lead times when it comes to costs for products, shipping, and more. For these reasons, some companies are witnessing abnormal costs that are out of proportion to revenue trends in a given quarter due to continued supply chain constraints.
CFO David Weigand tried to address these concerns:
We expect gross and operating margins to gradually increase this year, driven by product and customer mix, production efficiencies in new AI GPU clusters and new platform introductions. If [CEO Charles Liang] discussed, near-term supplies may still be constrained by supply chain bottlenecks for key new components for advanced platforms. However, in the long term, gross margins will benefit from lower production costs as we scale up production in Malaysia and Taiwan, in addition to expansion in the Americas and Europe.
Weigand’s explanation makes perfect sense. As manufacturing capabilities reach higher efficiencies thanks to new manufacturing centers in Asia, Europe and North America, Supermicro should begin to realize a more normalized relationship between revenue and cost growth. This, in turn, will improve the company’s profitability figures over time.
Why now is a good time to invest in Supermicro
Supermicro currently trades at a price-to-earnings (P/E) ratio of 31.3. This is a bit pricey, even for a growth stock, but shares are trading well below their previous highs on a price-to-earnings basis.
Investing in Supermicro should be rooted in two main ideas. First, you must have a strong belief about AI and its ability to continue generating impressive revenue growth for the company. But more importantly, you need to focus on the company’s path to better profitability.
Given Supermicro’s position in the IT infrastructure landscape and the continued secular tailwinds that AI is fueling, the company appears to have a winning recipe.
Investors with a long time horizon should seriously consider taking advantage of Super Micro Computer’s recent sell-off and relatively low valuation. It won’t be long before the company shows margin improvements, and if that happens, the stock could easily soar back to its previous highs.
Should You Invest $1,000 in Super Micro Computer Now?
Consider the following before buying shares in Super Micro Computer:
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Adam Spatacco holds positions at Nvidia. The Motley Fool holds positions in and recommends Advanced Micro Devices and Nvidia. The Motley Fool has one disclosure policy.
1 Beaten S&P 500 Artificial Intelligence (AI) Stocks Down 30% to Buy Hand Over Fist Now was originally published by The Motley Fool