With its shares up by over 4,000% in the past five years, an investment in Super Micro Computer (SMCI 3.69%) has been life changing for early investors. To put things in perspective, a $1,000 investment in mid-2019 would be worth $41,000 today, compared to just $1,760 in the S&P 500.
But can this Silicon Valley hardware company continue trouncing the market as AI-related hype takes a back seat to fundamentals? Let's dig deeper into what the next half-decade could have in store.
A fundamentals-based rally
Just like in the California Gold Rush of the 19th century, the artificial intelligence (AI) megatrend is boosting "picks and shovels" companies that sell enabling hardware more than it's boosting their consumer-facing clients (the metaphorical miners). While Super Micro doesn't design and manufacture AI training chips like its partner Nvidia, it helps turn these products into energy-efficient servers that its clients can use in their data centers.
Fiscal second-quarter earnings highlight the tremendous growth in demand for Super Micro's hardware. Net sales more than doubled year over year to $3.66 billion, while profits rose 68% to $296 million as current and new customers scrambled for more of its AI-optimized computer platforms.
Super Micro enjoys a close relationship with graphics processing unit (GPU) maker Nvidia, which gives it an allotment of chips to build its computers. New GPUs like the Nvidia GB200 (expected to launch this year) could lead to another surge of demand from Super Micro's data center clients. The company is also releasing more products based on chips created by Nvidia rival AMD, a move that can help diversify its supply chain and make it less vulnerable to possible shortages.
What could go wrong?
AI hype won't last forever, so Super Micro's clients will have to start generating earnings and cash flow capable of justifying their continued spending on expensive AI GPU chips and computer servers. This challenge is particularly pressing for Super Micro because of its low diversification and relatively weak economic moat.
Image source: Getty Images.
As mentioned earlier, Super Micro doesn't design AI chips. Instead, it is piggybacking on the innovations of Nvidia and other companies.
This intermediary position could expose it to margin-eroding competition from rival server makers like Dell Technologies, which could encroach on its GPU allotment or customer base. The fact that Super Micro's second-quarter gross margin fell from 16.7% to 15.4% speaks to its vulnerable position in the market. To put those numbers in context, Nvidia's gross margin rose from 74% to 76% in the corresponding period.
Is Super Micro stock a buy?
Super Micro Computer faces a lot of opportunities and challenges over the next five years. This will be a time of reckoning for artificial intelligence as hype fades, and companies must prove that they can turn this new technology into sustainable profit-generating businesses. But as a server maker, Super Micro has no control over its chip supply or the consumer side of the industry, which will determine its future.
That said, with a forward price-to-earnings (P/E) multiple of just 30, Super Micro remains relatively affordable, considering its triple-digit growth rate. And this discount seems to price in the uncertainty about future demand.
Shares still look like a buy -- although I would like to see more signs that AI is transitioning away from an experimental novelty into a major profit driver for businesses before considering a position in the stock.
