Super micro computer stock falls on recent news. Time to buy or stay away?

It’s been a tough few months for Super Micro Computer (SMCI -1.07%)whose stock has been under pressure for several reasons this year. Shares first fell in April following a mixed reaction to third-quarter 2024 results. That trend extended to the release of fourth-quarter earnings in early August, with shrinking margins worrying investors.

The company was then the subject of a short-selling report in late August from Hindenburg Research, which accused the company of accounting manipulation, sanction evasion and proprietary related-party trading by management. Not helping matters, the company delayed its 10-K filing shortly after the short report, though management denied any wrongdoing.

On September 26, the stock sank further following a report from The Wall Street Journal claiming that the Department of Justice (DOJ) is also investigating the company. Neither the DOJ nor the company have confirmed the investigation.

And most recently, Supermicro completed its 10-for-1 stock split on October 1. These mixed developments have made the stock highly volatile, with the stock down 66% from its March peak. But Supermicro is still up more than 45% year-to-date, and that begs the question: What should investors do with the stock now?

So what does he do? Does Super Micro Computer do anyway?

Supermicro designs and manufactures servers and storage systems. It assembles what are commonly called white box servers, which are basically generic brand versions of servers, using commercially available retail computer parts. It competes with other white box server vendors as well as branded offerings from della, Lenovoand Hewlett Packard Enterprise.

The company has benefited from the massive expansion of data centers as part of the artificial intelligence (AI) craze. The company’s revenue rose 143% in the fourth quarter of fiscal 2024 (ended June 30) to $5.31 billion. Supermicro credited its next-generation air-cooled AI GPU platforms and DLC rack for strong growth. These systems are used to prevent servers from overheating and failing, while reducing energy costs.

While Supermicro has led strong AI tailwinds, it is ultimately in a highly competitive, low-margin business without much differentiation. Its revenue may have grown in the latest quarter, but its gross margin fell to 11.2 percent from 17.0 percent a year ago and 15.5 percent in the previous quarter. The company put the margin pressure on a combination of product mix, low prices to win new models, and the cost of ramping up its direct liquid-cooled (DLC) rack AI GPU clusters. Management expects its gross margin to gradually improve through fiscal 2025 and return to a range of 14% to 17%.

An 11% gross margin is slim, and even 17% isn’t exactly robust. By comparison, the chip companies powering the building of AI infrastructure have much higher gross margins with both Nvidia and Broadcom having gross margins of at least 60% in the last quarter.

Image source: Getty Images.

Should investors be concerned about a possible DOJ investigation?

At this point, the brief’s allegations against Supermicro are just that, allegations. And investors should know that Hindenburg Research released the report in hopes of driving the stock price down to benefit its short position. The company managed to do just that.

Meanwhile, the DOJ probe reported by The Wall Street Journal remained unconfirmed by DOJ officials and company management.

That said, Supermicro has run afoul of US regulatory agencies in the past. The SEC fined the company in 2020 for accounting issues after it accused the company of shipping products to warehouses at the end of the quarter and recognizing it as revenue before the products reached customers. Ultimately, the company agreed to pay a $17.5 million fine without admitting or denying the details of the SEC’s investigation.

Given that history, the Hindenburg report and the DOJ news are a little concerning. However, Supermicro still sells real products, has real customers, and benefits from the rapid development of AI.

Is it time to buy the stock or stay away?

Even before the company’s latest travails, I didn’t think Supermicro was a particularly good investment given its margin profile and expensive stock. Following these reports, the bull’s case becomes even harder to accept.

In terms of valuation, however, the recent selloff has made the stock much more attractive, with a forward price-to-earnings (P/E) ratio below 10 and a price-to-earnings-growth (PEG) ratio of just 0.2. . A PEG ratio below 1.0 is generally considered undervalued. However, as the chart below shows, it has been quite common for stocks to trade at even lower valuations in the past.

Data by YCharts.

Given the uncertainty surrounding the stock, I would stay on the sidelines. However, this is not a situation where investors should rush to sell their positions given Supermicro’s current valuation and rising AI spending.