There is only one stock that can make the gains made by Nvidia (NASDAQ:NVDA) over the past three years look paltry in comparison. Super Micro Computer (NASDAQ:SMCI) stock has returned 1,124% for investors since the artificial intelligence (AI) boom began in late 2022. Nvidia returned 741%.
Where Nvidia is the face of AI with its powerful semiconductors that can handle the complex processing demands the technology requires, Super Micro Computer is the face of data center servers deploying AI chips. Supermicro, as it’s known, is famous for making the data center hardware more rapidly adapt to the new requirements of chips better than the competition. And therein lies the risk.
Blowout Numbers for Nothing
Super Micro Computers reported stellar fiscal third-quarter results at the end of April that showed sales of servers, storage, and other systems for cloud-to-edge customers tripled from last year and were up 5% sequentially. Profits more than quadrupled to $406 million year-over-year and were 35% higher from the fiscal second quarter.
President and CEO Charles Liang said, “Strong demand for AI rack scale (plug-and-play) solutions, along with our team’s ability to develop innovative (direct liquid cooling) designs, enabled us to expand our market leadership in AI infrastructure.”
Yet it wasn’t enough for Wall Street. Super Micro Computer stock plummeted 17% and dragged down much of the tech sector with it. Nvidia stock was down 5%. But where much of the rest of the industry recovered (NVDA is 30% higher), Supermicro stock remains 2% below where it stood before the quarterly earnings report.
Why hasn’t Super Micro Computer stock recovered like everyone else? Profit margins.
Entering a More Competitive Environment
Although Supermicro’s gross margins inched higher to 15.5% from 15.4% in the second quarter, they plunged 210 basis points from the year-ago period. That might not improve going forward. Because the hardware maker is competitively priced in an increasingly competitive market, Supermicro might not see any margin improvements. Gross margins could sit in the 15% range and may even deteriorate further.
In a bid to maintain its growing market share in the rack scale server market, Supermicro faces some bigger, better-financed rivals that will want to increase their own share in the space.
And despite Supermicro’s ability to quickly adapt new chip technologies to data center needs, the gap with the competition is narrowing. The hardware maker may need to become more competitive in terms of price to maintain its current dominant position atop the market. As there is not all that much differentiation between rival components and its own, Wall Street is questioning Supermicro’s near-term profitability lead.
Innovations That Make a Defining Difference
There seems little question Super Micro Computer will be able to keep growing sales in the data center market simply because of the massive demands from hyperscalers scooping up AI accelerators. But it is not likely to see margins expand in the same manner.
That helps explain why analyst one-year consensus price target on Super Micro Computer stock is just $954 per share. Its just 9% above where SMCI currently trades but 22% below the all-time high hit back in early March.
But I think that’s an opportunity for aggressive investors. Super Micro Computer is developing an innovative lead in its own technologies, such as direct liquid cooling. Liang told analysts last month that it is now ready for high-volume production of its latest iteration.
DLC innovations allow Supermicro customers to save money cooling expenses as well as data center space. Data center energy consumption is one of the biggest future hurdles the industry faces and Supermicro can help mitigate much of those concerns, keeping it in its leadership role.
A Hidden Opportunity
With Wall Street expecting Supermicro to grow earnings at a compounded annual growth rate of 62% for the next five years, it means Super Micro Computer stock is trading at just a fraction to that rate. And although it deserves the premium it sports across other metrics, shares trade at only 25 times next year’s earnings estimates.
Super Micro Computer stock is really offered at a discounted valuation now. Investors may want to use the opportunity to buy now before Wall Street realizes its error.
On the date of publication, Rich Duprey did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
