Super microcomputer (NASDAQ:SMCI) is currently quite a complicated investment. On the one hand, it makes server components and entire servers that are in huge demand thanks to artificial intelligence (AI). On the other hand, there are allegations of accounting malpractice and a Department of Justice (DOJ) investigation looking into these concerns.
Right now, the bear scenario outweighs the bull scenario, which is why shares of Supermicro (as the company is known) are down 60% from their all-time high in March. Additionally, the company recently underwent a 10-for-one stock split, a catalyst that typically causes the stock price to rise, not fall.
So is this a stock to stay away from? Or is it an opportunity to own an undervalued and potentially big winner?
Supermicro’s product is at risk of being commoditized
Let’s start with the company itself – and there may be other concerns here to take into account. The space for Supermicro’s products is quite saturated these days due to the many competitors.
However, Supermicro has one important advantage: it has the most energy-efficient technology available. Because energy is a significant operating expense for these servers, companies consider their total operating costs. This pushes a huge amount of demand for Supermicro.
However, this is not without its own problems. Supermicro’s gross margin has collapsed due to the new liquid-cooled technology, as the supply chain has bottlenecked the key components in these new systems. Management expects gross margins to increase throughout fiscal 2025 (ending June 30, 2025), driven by customer mix and manufacturing efficiencies as it scales up production in Malaysia and Taiwan, which should ease the bottlenecks it is currently experiencing .
While this may be true, there may be something else going on here. When a product becomes commoditized, companies that make it have to reduce their margins in order to compete. This could happen to Supermicro’s business, which doesn’t bode well for the company even though it has the best products in its class.
This will be an important trend to watch in the coming year, as low gross margin could break Supermicro’s investment thesis.
Allegations of accounting malpractice have prompted a government investigation
Then there are the allegations and the government investigation. Well-known short seller Hindenburg Research released a report in late August alleging account abuse at Supermicro, something for which the Securities and Exchange Commission had already fined Supermicro $17.5 million in 2020. Although Supermicro’s management has denied these allegations, it has not done itself any favors. when it announced that it had postponed the filing of its year-end Form 10-K with the SEC the day after Hindenburg’s report was published due to its review of “internal controls over financial reporting.”
It’s worth remembering that Hindenburg is a short seller, so he benefits if the share price falls. However, these allegations were so serious that the DOJ launched an investigation into Supermicro to determine whether they were justified. It will be some time before we know the results of this study, so investors face a difficult choice.
I wouldn’t blame anyone for tossing Supermicro into the “too hard to understand” pile. There is no shame in this conclusion. One of the greatest investors of all time, Warren Buffett, often does this to companies he doesn’t understand. With shrinking gross margins and an ongoing DOJ investigation, there are certainly a lot of negatives surrounding Supermicro.
But there are also some positive points. In fiscal 2025 (ending June 30, 2025), Supermicro expects its revenue to grow between 74% and 101% year over year. That’s enormous growth, but the share is still priced at a dirt-cheap level.
At just 14.2 times forward earnings, Supermicro might be one of the cheapest companies you’ll ever come across posting such growth rates. So if Supermicro’s management is right and it improves gross margin and shows strong growth throughout fiscal 2025, the stock has a huge upside as it is well below where the S&P500 transactions (at 23.7 times forward earnings).
I think there’s enough compelling investment thesis here that I bought the dip in the stock. However, I only let it take up about 1% of my portfolio because there is a lot of risk involved. Supermicro is all about risk tolerance and risk management. If you don’t agree that this stock is losing money because of the potential for strong gains, there are still plenty of other AI stocks that are a good choice.
But there’s a good chance this stock could double — as it solves some of its shortcomings.
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Keithen Drury holds positions in Super Micro Computer. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
Super Microcomputer: Is This Stock Split a Buying Opportunity or a Trap? was originally published by The Motley Fool
