Super Micro Computer (NASDAQ:SMCI) has continued its dramatic ascent as investors ponder the company’s long-term potential. The company got a head start with AI servers and cornered the market last year. High revenue and earnings growth fueled a massive rally that has resulted in a 1,050% gain over the past year. The firm is now worth over $62 billion. While the stock can still ride higher thanks to high AI demand and analyst price hikes, the long-term perspective has a few key risks to consider.
Don't Miss our Black Friday Offers:
- Unlock your investing potential with TipRanks Premium - Now At 40% OFF!
- Make smarter investments with weekly expert stock picks from the Smart Investor Newsletter
I am neutral on SMCI because it’s impossible to predict how far a rally can carry a stock. However, I can quickly become bearish if at least one of the long-term risks discussed below becomes more significant.
The Size of the AI Pie
Super Micro Computer has enjoyed relatively little competition for most of 2023, but that appears to be changing. Dell (NYSE:DELL) reported a massive backlog for its AI servers and indicated that more growth is on the way. The tech giant reported a 40% quarter-over-quarter increase in AI server orders.
Corporations are making big investments in artificial intelligence, but those investments will eventually slow down. Before big firms reduce their spending, other server companies will grab their slice of the pie.
Dell has already started and now presents a viable alternative to Super Micro Computer. These two companies can enter a pricing war that results in lower profits for both of them. Hewlett Packard Enterprise (NYSE:HPE) is also getting into AI servers, which will result in even more pricing pressure.
SMCI is priced as if it doesn’t have any competition, but that can change in the long run. The corporation can experience pressure on its stock price before other competitors gain market share if various businesses decide to pull back on AI spending.
Profit Margins Didn’t Increase as the Business Grew
A big component of Nvidia’s (NASDAQ:NVDA) rally has been its rising profit margins. The AI giant closed its fourth quarter of Fiscal 2024 with a net profit margin above 50%. Furthermore, GAAP net income growth outpaced Nvidia’s stock gains.
On the contrary, Super Micro Computer’s profit margins worsened in its second quarter of Fiscal 2024. Its net profit margin was only just above 8% compared to a net profit margin above 9% during the same period last year.
Bullish investors will make the argument that a slight dip in profit margins doesn’t matter since the company reported 68% year-over-year net income growth. It’s a fair point, but the industry’s reputation for low-profit margins doesn’t offer much upside in that area.
SMCI is currently relying on revenue growth to fuel higher profits. Revenue growth rates seem like the ceiling at the moment, which can be troubling when revenue growth slows down. The firm’s guidance suggests $3.7 billion to $4.1 billion in total revenue for the third quarter of Fiscal 2024. SMCI’s $3.66 billion in Q2 FY24 revenue means current projections suggest a quarter-over-quarter growth rate of 1.1% to 12%.
Investors can argue that growth is already slowing down if revenue comes within the $3.7 billion to $4.1 billion range. Combining multiple reports with low quarter-over-quarter growth rates will eventually result in an entire year of low growth. That development will minimize the company’s net income gains. Earnings growth over the past year is already drastically behind stock gains over the past 12 months. That’s concerning.
Super Micro must exceed guidance to demonstrate the growth story is strong since investors already anticipate revenue going as high as $4.1 billion.
Everyone’s Talking About the Valuation
It’s impossible to have a conversation about SMCI without mentioning its valuation. Bulls will argue that Super Micro Computer stock has a reasonable valuation based on future growth prospects, while bears will claim the valuation is elevated and offers limited upside.
A high valuation isn’t always a bad thing. Some stocks grow into their valuations as they explore new opportunities and expand their profit margins. However, the two problems mentioned earlier compound the significance of SMCI’s lofty valuation.
Its valuation has earned it comparisons to dot-com stocks like Qualcomm (NASDAQ:QCOM), which soared as new technology gained rapid demand. Qualcomm enjoyed a great run and surged by roughly 3,000% from January 1996 to January 2000. It had the type of fanfare that SMCI stock enjoys today.
Fiscal years that ended in 1996 and 1997 featured triple-digit year-over-year revenue growth. The fiscal year ended in 1998 had roughly 60% year-over-year revenue growth. The stock derailed in 2000 after reporting negative revenue growth in that year. The company also reported negative revenue growth in 2001.
Super Micro Computer isn’t likely to follow the same exact path as Qualcomm, but history rhymes. SMCI stock may have one year left before it implodes, or it can have five years remaining. If quarter-over-quarter revenue growth falls below 10%, we can see the former rather than the latter.
Is Super Micro Computer Stock a Buy, According to Analysts?
Super Micro Computer stock has a Moderate Buy rating based on six Buys and three Holds assigned in the past three months. The average SMCI stock price target of $983 suggests shares will drop by 12.4%.
The Bottom Line on SMCI Stock
The stock’s rally has been getting out of control. The company can assuage critics by beating revenue estimates, making the stock’s quarter-over-quarter growth rate more impressive. This growth matters more than year-over-year revenue growth since investors already anticipate that the stock will deliver a triple-digit growth rate on that front.
Valuation isn’t the only concern, though. Rising competition, the prospect of corporations pulling back on their spending, and low profit margins also play a role. SMCI is priced as if the corporation will not encounter any of these problems, but they are notable risks.
SMCI started out as an undervalued stock near the end of 2023. However, the stock’s 295% year-to-date gain doesn’t leave a margin of safety since net income ‘only’ increased by 68% year-over-year.
