A stock that could rise after its Oct. 1 split

Stock splits are usually good indicators of strength because companies normally only split their stock after the price of an individual stock has become expensive. Super Micro Computerhis (SMCI 1.07%) the split is coming soon — the company expects its 10-for-1 split to take effect on Oct. 1 — but it hit a rough patch shortly after announcing it.

Since then, the stock is down about 32%. There are a few reasons for this, but I don’t think any of them justify avoiding stocks as a long-term investment — although investors need to be aware of the risk they’re taking on.

Supermicro products are in high demand

Super Micro Computer manufactures data center components and builds complete servers. This has been a good business for the past few years and has been a phenomenal business lately. Due to the unprecedented demand for artificial intelligence (AI), companies are rushing to expand their computing capacity. This has allowed businesses like Supermicro to grow as it is a key supplier in this space.

While it has many competitors, none offer as customized a complete server solution as Supermicro. And its liquid-cooled technology gives customers the most energy-efficient server available, saving long-term operating costs.

These factors have combined to make Supermicro the top choice for data center components and full server builds, which is why the stock has performed so well this year.

But there’s more to Supermicro’s investment thesis than best-in-class products.

Two factors cause the stock to struggle in the short term

Since the stock peaked in March of this year, it has fallen steadily. Some of this decline is justified because stock price expectations at the time were unrealistic. However, the levels it has fallen to are too cheap, creating an interesting investment opportunity.

The reasons for the stock’s latest drop following its fourth-quarter earnings report (ended June 30) are twofold. First, Supermicro’s gross margins have declined in many quarters.

SMCI gross profit margin (quarterly); data by YCharts.

That’s not a great sign – falling gross margins may indicate that Supermicro’s products are becoming a commodity and it’s losing its pricing power. However, management blames the launch of its new liquid cooling technology and other new products for the decline. It believes these gross margins will recover during fiscal 2025 and return to long-term historical norms.

Regardless, this will hurt short-term returns, which investors don’t want to see. This caused stocks to fall initially following the earnings.

The second reason for the decline is Hindenburg Research, a notorious short-selling firm that benefits when stock prices fall. Hindenburg published a short seller report alleging accounting malpractice by Supermicro, for which the company had already been fined by the Securities and Exchange Commission (SEC).

To make matters worse, Supermicro has delayed filing its year-end Form 10-K with the SEC as, management said, it evaluates “the design and operational effectiveness of its internal controls over financial reporting.” If you can’t trust the financials that a company reports, the stock becomes unworthy of an investment, which is why many dumped the stock following the report.

But the company does not expect any change in its financial results. So this could be a wake-up call for management to get its act together, and likely won’t be a long-term factor, assuming the financials don’t change and the Hindenburg report turns out to be inaccurate.

However, this is not the end of the Hindenburg saga. Shortly after the Hindenburg report, the US Department of Justice opened an investigation into Supermicro. This probe may come up with nothing. However, there is a possibility that this will lead to further actions, so the risk of investing in Supermicro has increased. Investors have a long wait until the results of this investigation are known.

Meanwhile, these two short-term factors driving the stock lower have opened up a long-term investment opportunity if it turns out the company was not involved in accounting malpractice. This can be seen in its forward price-to-earnings (P/E) ratio, as the stock trades for a very cheap 12 times forward earnings.

SMCI PE report data (before) by YCharts.

That’s cheap for any stock, let alone one that’s poised to grow earnings between 74% and 101% in fiscal 2025. Combine that with ever-improving margins, and you’ve got a recipe for a stock that could have a strong year once other questions are resolved. outside.

I think Supermicro stock could go up after its split. Many short-term factors are dragging it down, but if these are resolved favorably, Supermicro is poised to earn excellent returns due to massive demand for its products.

For now, there is an increased risk to investing in Supermicro due to an ongoing government investigation. This shouldn’t make you ignore stocks completely, assuming you’re willing to take the risk, but it should guide your position sizing if you choose to invest in stocks sometime soon.