With shares up by over 700% in the past 12 months, Super Micro Computer (SMCI 1.28%) has been one of the biggest beneficiaries of the artificial intelligence (AI) boom, even outpacing giants including Nvidia, which rose 230% in the same period. While the company doesn't design and manufacture its AI chips, it helps turn these items into ready-to-use computers and servers for its data center customers.
But while Super Micro's business is booming, has its explosive rally put shares outside reach for value-conscious investors? Let's dig deeper to find out whether this stock is still a good long-term buy.
Why is Super Micro booming?
Historically, Super Micro has been a relatively cheap company. At the start of 2023, its shares were worth just under 10 times earnings, which was a dramatic discount to the S&P 500 average of around 27.
NASDAQ: SMCI
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The discount probably had a lot to do with Super Micro's business model. Unlike many of the largest technology companies, it doesn't specialize in software -- which tends to attract premium valuations because of its high margin and scalability. The company also doesn't design and manufacture high-priced chips as Nvidia or AMD do. Instead, it turns these cutting-edge products into computer servers that data center customers use to run websites, AI algorithms, and other applications.
Super Micro is benefiting from soaring demand for AI-related data center hardware. Fiscal second-quarter sales jumped by 103% year over year to $3.66 billion while net income increased a much more modest 68% to $296 million. But it's unclear how much steam the rally has left.
Can Super Micro's rally continue?
Some analysts are still optimistic about Super Micro, with Rosenblatt securities giving it a 12-month price target of $1,300, a potential 81% upside, based on projected increases in AI-related demand. But there are some reasons investors might want to stay cautious.
For starters, Super Micro doesn't have a particularly deep economic moat. According to the Financial Times, many of the largest data center operators, including Amazon, Microsoft, and Alphabet, can build their own computer servers. That means Super Micro's products have limited pricing power and demand inelasticity. In other words, if prices for its servers get too high, consumers may seek out alternatives.
And unlike Nvidia, which saw its gross margin rise from 54% to 74% year over year in the third quarter, Super Micro's explosive top-line growth isn't improving its pricing power.
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The server maker's gross margin fell from 18.7% to 15.4% in its most recent earnings report. And as supplies from chipmakers like Nvidia become more expensive, Super Micro may struggle to pass on all these costs to final consumers, leading to continued margin weakness.
What could the next five years have in store?
After its rocket-ship rally, Super Micro Computer now has a price-to-earnings (P/E) ratio of around 62, which is a significant premium over both the S&P 500's average of 27 and Nvidia, which trades for just 34 times its forward earnings. These numbers suggest Super Micro is overvalued.
Nvidia's stronger economic moat and higher margins mean its bottom line will probably grow much faster than the smaller alternative.
Over the next five years, Super Micro can continue to beat the market, simply based on the momentum of the fast-growing AI industry. But right now, the stock is priced for perfection. And it will need to justify its valuation or face a correction. Investors may want to take profits or hold off buying shares until more information becomes available.
