Perhaps the biggest business powering the markets right now is artificial intelligence (AI). It seems like every software developer is eager to capitalize on the AI excitement, and technology stocks are taking advantage.
As S&P 500 And Nasdaq Composite Trading at record levels, I have my eye on one stock in particular. The best part? It’s not in the “Magnificent Seven.”
Shares of Super Micro Computing (SMCI -5.42%) That’s a 5,830 percent increase in just five years. So far in 2024, they are up more than 300% as of the market close on March 8. Much of the momentum driving the stock right now revolves around the company’s latest milestone: inclusion in the S&P 500.
This company is playing a leading role in the AI field. Let’s delve into Super Micro’s business and gain an understanding of why the stock is going parabolic.
A wonderful race to the top, but…
Supermicro plays an important role at the intersection of semiconductors and artificial intelligence (AI). The company designs integrated systems for IT architecture, which may include storage clusters or server racks.
Given the growing interest in graphics processing units (GPUs) from the likes of Nvidia And Advanced Micro Devices Over the past year, Super Micro’s services have been in high demand in the background.
SMCI Revenue (Quarterly) data via YCharts.
Revenues are growing at over 100% annually, and AI tailwinds create an encouraging long-term outlook. It’s no wonder that one Wall Street analyst called Super Micro a “stealth Nvidia.”
As with all businesses, there’s much more to the picture than a sales boom — more than just the moment. Let’s look at some other factors to improve the overall investment thesis here.
There are some lingering concerns.
One of the most important things for investors to understand is that Supermicro is very much a hardware operation, and its margin profile is much lower than you might think.
For the quarter ended December 31, gross margin was 15.4%. This represents a decrease compared to the previous quarter. And same period last year. Management shrugged off the margin deterioration during the earnings call, explaining that it was due to aggressive investments in new designs and market share gains.
Spending to grow is an argument that only goes so far. In the long run, Super Micro has to prove that margin expansion and consistent cash flow are achievable.
Image source: Getty Images.
Values are becoming disconnected from fundamental principles.
Given the role of semiconductors in the AI revolution, it makes some sense that stocks like Nvidia and AMD are gaining attention. However, Supermicro’s close association with these chipmakers has brought some momentum to the picture. This dynamic can carry a lot of risk, as investors may think they are buying into the next Nvidia.
But as mentioned above, Supermicro and Nvidia are very different businesses. At best, they are tangentially related. More appropriate comparisons are included. Hewlett Packard Enterprise, Lenovo, DealAnd IBM. Its stock currently trades at a price-to-sales (P/S) ratio of 7, twice that of IBM.
Not only is Super Micro by far the most expensive stock among this group, but the other companies mentioned above have more stellar businesses all around. It is a highly specialized operation and not as diversified as, for example, IBM or Dell.
I see this as an interesting way to invest in AI. The company operates in an important pocket of the AI landscape, albeit under the radar.
But with shrinking margins and rising valuations, the stock’s premium appears increasingly less connected to fundamentals. While inclusion in the S&P 500 is a respectable milestone, it’s not reason enough to chase the stock even though it can grow as ETFs and passive funds rebalance their portfolios to add new stocks to the index. are
For now, I will sit on the sidelines and monitor the company’s performance. If the supermicrocomputer is going to be an influential part of the AI narrative in the long run, investors will have plenty of opportunities to buy at more reasonable prices.
Adam Spatacco has positions in Nvidia. The Motley Fool has positions and recommends Advanced Micro Devices and Nvidia. Motley Fool International recommends Business Machines. The Motley Fool has a Disclosure Policy.