Aehr Test Systems (AEHR -0.28%) is a little-known stock that's helping power the electric vehicle (EV) movement. The company knocked another one out of the park on its last quarterly earnings update, getting a huge lift from the sale of equipment it makes for a niche within the semiconductor industry. Share prices are down about 17.6% so far in 2022, but that's far better than the 41.3% drop for semiconductor stocks overall as measured by the iShares Semiconductor ETF.  

Can Aehr Test Systems run higher from here as EV production continues its relentless expansion?

New cars, new materials needed

Silicon is the basic substrate material that electronic computing devices are built on. You've probably seen images of these thin circular silicon objects before, perhaps being held by someone in a white lab suit. Silicon is an ideal material for mass producing chips because of its semiconductive properties, but also because it's plentiful and cheap. 

New chip applications, like EVs, demand new substrate materials, though. Subjected to extremely high temperatures because of fast-charging technology, a basic silicon chip would quickly fry in an EV. That's why silicon carbide (SiC) is getting attention. It's a bit more expensive than straight silicon, but it holds up well to the demanding conditions of vehicle electrification. 

SiC is finding use in other applications as well, like EV charging stations, high-end communications network equipment, and solar and wind energy (and the utility-grade batteries that are often getting paired with new solar and wind projects). 

So what does all this mean for Aehr Test Systems? The tiny company has been around for decades, but it has developed new equipment systems that test SiC wafers and packaged parts for functionality. Given the high cost of SiC-based chips and the critical systems they are powering in EVs and other applications, testing the integrity of SiC wafers is critical before they go on to the next step of chip manufacturing.

Aehr had a record-setting fiscal 2022 (ended May 31), and it got its new fiscal year started on the right foot, too. First-quarter fiscal 2023 (which ended Aug. 31) revenue was up 89% year over year to $10.7 million, and adjusted net income was $1.3 million compared to an adjusted net loss of $414,000 the same period last year. Aehr closed out August with $36 million in cash and equivalents and no debt.  

Aehr is hot, but it's not for everyone

Aehr management reiterated its full-year fiscal 2023 guidance for revenue between $60 million and $70 million (up 28% at the midpoint of guidance), but said there's significant upside as new and existing customers have expressed interest in purchasing more equipment to ramp up their SiC production. The company also frequently cites a report from researcher Canaccord Genuity that estimates SiC wafer production capacity will increase from 125,000 in 2021 to over 4 million in 2030 due to the EV market alone.  

But before piling in on this small-cap growth stock, bear some risks in mind. Aehr faces off against some big competitors in the chip fab equipment market. For example, KLA and Applied Materials sell some adjacent SiC equipment that complements what Aehr does. Aehr has patents on its SiC testing machines. However, one of its peers could certainly develop a similar technology and get in on the wafer boom Aehr is enjoying right now.

Buying chip fab equipment is also expensive, and an economic downturn (or a slowdown in chip demand) could also bring Aehr's EV chip progress to a screeching halt. 

And one more thing: Shares aren't cheap. Aehr is just beginning to turn the corner on profitability. It generated just $4.65 million in free cash flow over the last year. If the company can scale up its operations, things will be OK. But for now, the stock trades for 117 times trailing-12-month free cash flow.  

With that kind of valuation, investors are betting the business will indeed continue to grow rapidly and reach a far more profitable scale in the coming years -- though that is far from a given at this point. But such are the risks of investing in small up-and-coming businesses. I own a small amount of Aehr stock, and I'll likely dollar-cost average into a larger position over time if the growth story continues. But it will be a wild ride. This EV chip equipment stock isn't for everyone.