Super Micro Computer (NASDAQ: SMCI) stock has experienced significant volatility this year. Super Micro Computer is a data center solutions provider that sells server systems, server boards, storage, networking solutions, management software, and installation and maintenance services. SMCI stock has increased nearly eightfold over the past two years – from about $6 per share in September 2022 to about $47 today, reflecting strong demand for servers from AI data centers as well as the recent stock split 10 to 1 can be attributed. However, the stock saw a significant decline earlier this year due to gross margin concerns, supply chain issues and a delayed 10-K filing after short seller Hindenburg Research accused accounting irregularities. So is Super Micro stock a buy, a hold or a sell?

(Also see Should You Buy, Sell, or Hold SNAP Stock at $12).

In our recent analyzes we have argued for a number of outcomes. On the one hand there is Potential for the stock to rise more than 2x to $1,000. On the other hand, we have presented a countercase that demonstrates this Super Micro stock could fall to levels around $200 per share.

Admirably, SMCI stock has delivered better returns than the broader market in each of the last three years. The stock's returns were 39% in 2021, 87% in 2022, and 246% in 2023. In contrast, the Trefis High Quality Portfolio, with a collection of 30 stocks, is significantly less volatile. And it has outperformed the S&P 500 every year in the same period.

Why is that? As a group, the stocks in the HQ Portfolio offered better returns with lower risk compared to the benchmark index. Less of a roller coaster ride, as the HQ portfolio performance metrics show.

Given the current uncertain macroeconomic environment surrounding interest rate cuts and multiple wars, could SMCI see a sharp rise?

Let's start with the bad first

There are concerns about whether demand can be sustained. The underlying economics of the broader AI ecosystem remain questionable at this point and most AI customers are still making losses. Building and training large language models is also expensive. We could be in an AI “FOMO phase” where companies feel compelled to invest in AI simply because their competitors are doing so. As Super Micro's end customers seek better returns, capital spending could slow, impacting growth. Additionally, most AI companies are currently in the compute-intensive training phase, and demand for computing power and server equipment may wane as they move into the less compute-intensive deployment phase. This could also impact demand for Super Micro's server systems, server boards, storage and networking solutions.

The corporate governance concerns raised by Hindenburg Research deserve particular attention, although the full extent of the problem remains unclear. The short seller alleges that Super Micro may have engaged in misrecognition of revenue, allegedly recording incomplete sales and circumventing internal controls. In addition, the company is accused of questionable relationships with related parties, particularly suppliers linked to the CEO's family. Hindenburg also points to the reinstatement of executives previously implicated in previous scandals shortly after the company settled with the SEC. While these questions are concerning, more information is needed to fully assess the situation.

Additionally, Super Micro's margins are also vulnerable. Although net margins increased from 6% in fiscal 2022 to approximately 9% in fiscal 2024 due to greater economies of scale, they could decline significantly if sales decline and competition increases, reducing the Company's volumes and pricing power. Additionally, SMCI's gross margins have been under some pressure in recent quarters as the company sells a wider range of liquid cooling systems that are proving expensive to manufacture, and this trend may continue. The server market is also highly standardized. Although Super Micro has some competitive advantages because its products are considered more customizable, the company's lead in these areas is hardly unassailable and competition could increase significantly.

The good and the great

While the first AI models deployed in 2022 by companies like OpenAI were largely text-based, the models are increasingly multimodal, meaning they work with voice, images, videos and 3D content – requiring greater computing power and a larger number of GPUs -Delivery required. Furthermore, in the AI ​​era, the demand for computing power has skyrocketed due to the high computational demands of machine learning, unlike about a decade ago when advances in computing power – particularly processors – outpaced the development of software that could fully utilize these models . If computing needs continue to rise, Super Micro could also see an increase in demand as the company's infrastructure tools are required to support expansion.

The change in US monetary policy could also give SMCI an additional boost. The Fed's 50 basis point rate cut – the first in nearly four years – brings the key interest rate to between 4.75% and 5% and provides room for further cuts. Lower interest rates strengthen growth sectors like technology by increasing the present value of future earnings. The interest rate cuts will particularly benefit SMCI. Why? Lower interest rates would reduce financing costs for large data center builders and potentially boost capital spending in the area. Furthermore, the economics of the AI ​​revolution remain inconsistent given the high costs of model training and inference. A decline in interest rates could improve the financial viability of these investments. Check out our analysis of other ways you can benefit from the Fed's next move.

Although the server market is standardized, Super Micro has some competitive advantages because its products are considered more customizable and energy efficient than the competition. Super Micro's customers are also increasingly choosing premium products. For example, the company estimates that 30% of server racks shipped next year will have expensive liquid server cooling systems installed, which were relatively rare in the pre-AI era. In addition, the company is continually expanding its production capacities. For example, the company is building a new facility in Malaysia that can produce over 5,000 racks of server kits every month. This gives the company the opportunity to increase sales in the long term.

So what should you do?

Answer: Add SMCI to your portfolio so that while you expect a 5x profit in the long run, you are always ready to take a 50% loss along the way. Yes, be willing to endure short-term pain – the price you will pay – to be rewarded in the long run. This sounds simple in theory, but is never easy to implement in practice.

As investors hope for a soft landing for the U.S. economy, the question is how bad it can get if another recession hits. Our How Low Stocks Can Fall in a Market Crash dashboard tracks how key stocks have performed during and after the last six years Market crashes.

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