The stock of super micro computers continues to decline. Should you buy or sell?

Actions of Super Micro Computer (SMCI 7.92%) have grown by over 1,000% in the past three years. The stock is also down 65% from all-time highs.

The data center builder and accelerator of artificial intelligence (AI) infrastructure has taken shareholders on a wild ride in recent quarters. Revenues grew, but there were concerns about customer attrition and the formation of a potential AI bubble. Recently, there was a short sales report from Hindenburg Research that sent the stock further down.

No matter how right or wrong this short report is, long-term financial fundamentals are what will matter for Supermicro stock. Let’s see if now is a good time to buy the dip or if you should just cut your losses and sell.

Bet on an AI boom

You could say that Supermicro was in the right place at the right time two years ago. The company is an assembler and designer of large computing clusters, putting together complicated computer chips and things like cooling equipment to make data centers run efficiently. Companies like Amazon or even adze will outsource this and pay Supermicro to be the go-between for assembling the data center.

Following the growth of ChatGPT and the recent boom in AI infrastructure spending, the company has seen an increase in demand for its services. It is one of the key partners for companies such as Nvidia who sell the computer chips that power these new AI tools. With companies big and small racing to win in AI, speed and efficiency in data center design have been of great importance, which is why companies are turning to Supermicro.

And this strategy paid off nicely. Revenue for the fiscal year that ended in June was $15 billion, more than double the figure from the previous quarter. Earnings also exploded higher. Three years ago, the company was barely making money. Last fiscal year, operating income topped $1 billion.

When rapid revenue growth is a bad sign

One of the biggest mistakes novice investors make is to extrapolate recent income growth into perpetuity. This is what drives investors upstart who bought at the top in 2021 to lose more than 90% of their investment. The company grew revenue by more than 100% year-over-year a few years ago. Today, its revenue figure is much lower.

As noted investor Peter Lynch said, when looking at a company, sustainable growth is more important than a high percentage current figure. If earnings growth goes from 100% to spotty, the stock will likely do poorly. I think this is a risk for Supermicro.

Before the AI ​​boom, its revenue had been stagnant for years. This indicates that recent revenue growth can be attributed almost entirely to AI spending. Therefore, if AI spending slows, the company’s revenue could easily slow or even reverse from this $15 billion level.

Semiconductors and data centers are a cyclical market, albeit one that has grown in recent decades. There were, however, many explosions and meltdowns along the way.

It’s not guaranteed to hit a cyclical peak anytime soon, but investors bullish on Supermicro should be cautious. Just because it’s growing sales by 100% year over year doesn’t automatically make it a buy.

SMCI PE report data by YCharts; PE = price to earnings.

Stock looks cheap: is it?

Looking at Supermicro’s price-to-earnings ratio (P/E), the number isn’t too demanding. P/E is 20.5 which is way below S&P 500 broad market average. What that should tell any investor is that — after this 65% discount — the market isn’t expecting crazy growth in the coming years.

Believers in the AI ​​boom and continued capital spending by companies like Amazon might like Supermicro stock here. Rising spending on AI infrastructure likely means the stock is doing well in the short term.

My concern is the unpredictability of AI spending and the hyper-competitive nature of the industry. After the frenzied spending environment of recent years, is it slowing down? Will customers take more models indoors? It will direct competitors such as della do you take clients?

At the end of the day, it’s also hard to see why the company has any competitive advantage. All it does is assemble computer chips and sell packaged products to customers.

Nvidia is the company that actually leads the innovation on the hardware side of things, while Meta platformsOpenAI and Amazon are driving software innovation. It’s a classic smiling curve situation where the middleman doesn’t make much of the profit. This is why Supermicro has an operating margin of less than 10%.

For these reasons, I think it’s best for investors to avoid Super Micro Computer stocks even after this downturn. The broker rarely makes a profit in situations like these.