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IT infrastructure company Super microcomputer (NASDAQ:SMCI) was a favorite among artificial intelligence (AI) investors from the past year.
Earlier this month, Supermicro reported financial results for the fourth quarter and full fiscal year 2024 (ending June 30). TThe earnings report was a mixed bagbut management surprised investors by announcing a 10-for-1 stock split.
Let’s explore how stock splits work and provide examples of recent splits of similar AI companies to help form a thorough investment thesis around Supermicro right now.
1. How do stock splits work?
Stock splits are simply a financial engineering mechanism.
When a company goes through a split, the shares outstanding increase by the number in the split ratio (in Supermicro’s case, the number of shares is multiplied by 10 after the 10-for-1 split). Conversely, the company’s share price should then fall by the same factor.
For this reason, stock splits do not inherently change a company’s market capitalization or valuation. But as I’ll explain below, split news often attracts excessive attention, which can lead to abnormal trading volatility for the stock in question.
AI has become all the rage in the technology sector over the past year and a half. Supermicro’s close relationship with semiconductor darlings Nvidia And Advanced micro devices has helped take his company to a new level and cement it as an emerging growth opportunity for AI enthusiasts. Since January 2023, shares are up 652% at the time of writing.
One of the main reasons a company will split its stock is to make it more accessible. At a price of more than $615 per share, many investors likely consider Supermicro to be overpriced. If the 10-for-1 split were to occur today, the stock price would fall to about $62.
Again, while you would technically be buying into Supermicro at the same valuation, investors might view the stock as cheaper and be more likely to buy.
3. How are stock splits handled?
Brokerage firms such as Vanguard, Fidelity or Charles Schwab handle the mechanics in the background.
Let’s say you already own 10 shares of Supermicro at $500 per share. After the split on October 1, your trading account will automatically reflect your position of 100 shares purchased at $50 per share.
No work is required on your end.
Supermicro’s upcoming 10-for-1 split marks the first time the company will split its stock.
As I mentioned earlier, stock splits can get a lot of attention, which can affect stock price dynamics.
For example, too much momentum can impact a stock around the time of the split. As day traders pile into the stock, the stock price often starts to rise quite quickly.
This activity can lead to a significant increase in valuation in a short period of time, making the stock a riskier buy. I would encourage investors to be patient until momentum traders exit and make their quick profits. The last thing you want to do is buy a stock at a high valuation and be left holding the bag when traders suddenly sell out.
The chart above illustrates how Nvidia and Broadcom shares moved around their own 10-to-1 splits earlier this year. Broadcom announced the split on June 12, Nvidia on May 22.
Investors can see that both Broadcom and Nvidia experienced fleeting shocks to their stock prices shortly after making these announcements.
However, both stocks do rejected after the execution of their respective splits.
As a word of caution, I wouldn’t suggest looking for a perfect time to buy Supermicro. That said, recent examples show how buying too close to the split date can put you in higher-than-normal volatility.
A wiser strategy might be to wait until after the split and observe how the price action plays out. If there is a sell-off immediately after the split, you may be able to buy in at a more reasonable valuation.
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Charles Schwab is an advertising partner of The Ascent, a Motley Fool company. Adam Spatacco holds positions at Nvidia. The Motley Fool holds positions in and recommends Advanced Micro Devices, Charles Schwab, and Nvidia. The Motley Fool recommends Broadcom and recommends the following options: Short September 2024 $77.50 calls on Charles Schwab. The Motley Fool has one disclosure policy.
Here are 5 things smart investors need to know about Super Micro Computer’s 10-for-1 stock split was originally published by The Motley Fool