Super Micro Computer shares are very cheap again (NASDAQ:SMCI)

Investment thesis

My previous bullish thesis on Super Micro Computer stock (NASDAQ:SMCI) was destroyed by the stock market, as shares plummeted 49% since the beginning of June. As I have emphasized in most of my articles on SMCI, The stock is extremely volatile. I still do not recommend investing in SMCI for those investors who are not willing to tolerate massive volatility.

I am a long-term investor and prefer to allocate my capital to stocks with great potential. I am willing to hold it for decades, which means that declines like the recent ones create more buying opportunities. I prefer to look at companies from a secular perspective, and SMCI definitely has great potential. Moreover, the stock became very cheap once again after the recent drop. Overall, I reiterate my “strong buy” rating for SMCI.

Recent events

CISM It peaked at over $1,200 in March 2024. The current price is hovering around $413, which is almost three times lower. The stock is extremely volatile and the past 52-week range is from $227 to $1,229. The stock started experiencing a massive sell-off from mid-July, mainly due to the broader market factors. This roughly aligns with the stock’s historical seasonality patterns. The bar chart below suggests that the stock’s price decline is likely to continue into September.

Broad market sentiment around growth stocks began to deteriorate in mid-July, when there was a court Microsoft (MSFT) services stocks fell due to CrowdStrike (CRWD) cybersecurity software update. Fears around growth stocks were also fueled by the U.S. unemployment rate breaking through the psychological level of 4% during the summer of 2024.

The market is a short-term voting machine. Sentiment around the growth prospects of AI winners has seemingly cooled after Nvidia’s (NVDA) market cap surpassed $3 trillion. This is a huge psychological level for the entire market because none of the stocks rallied much beyond $3 trillion market cap. So it’s not surprising that NVDA investors are taking profits when the company’s market cap hits $3 trillion. Even the recent stellar quarterly earnings release didn’t help much. I think the market needs to get used to the new reality where companies’ market caps can approach $4 trillion before the rally resumes. Plus, September is Historically the weakest month for stocks.

Therefore, SMCI price could remain stagnant for the next few months. As a long-term investor, I prefer to ignore noise and short-term fluctuations in the stock price. Let me further explain why I strongly believe that SMCI remains a great investment opportunity based on fundamental factors.

The hardware industry for generative AI continues to thrive. In July, Gartner has significantly improved According to the report, generative AI is the main reason for this optimistic forecast. Spending on data center systems is expected to grow by 24.1% in 2024 compared to 2023.

Gartner’s optimistic outlook aligns with recent developments in the industry. Amazon’s (AMZN) AWS continues to expand its data center network and yesterday shared information that the company will invest around $100 billion in data infrastructure. 8 billion pounds sterling In the UK, asset management giants are also investing billions in data centres. For example, a consortium led by Blackstone (BX) is set to acquire Australian data centre group AirTrunk in a deal worth more than A$24 billion. Blue Owl Capital (OWL) is also planning to invest billions in a joint venture that will develop data centres. It is therefore too early to think that data centre investments are losing momentum.

As a company with a strong technology partnership with Nvidia, the leading AI winner, SMCI is poised to continue enjoying strong momentum in the industry. The company’s revenue is on the rise and has grown five-fold over the past five years. The consensus expects Nvidia’s revenue to triple over the next decade. This bullish outlook is crucial for investors as there is an extremely strong correlation between NVDA and SMCI’s revenue growth. I became even more convinced that the strong correlation of the two companies’ revenues will persist. after Jensen Huang described himself like Liang's [SMCI’s CEO] Long-time partner and “best seller” for Supermicro.

It is also very important that SMCI does not focus solely on building strong relationships with NVDA. Super Micro Computer also reacts quickly to new chip releases from AMD (AMD) Introducing servers that are compatible with AMD. SMCI also works closely with Intel (INTC) to ensure that its offerings are also compatible with Intel's. I therefore believe that SMCI is protected from the concentration risk related to Nvidia. With strong partnerships with the three leading AI chip companies, SMCI is well positioned to capitalize on growing investments in data centers.

Some analysts were less optimistic about SMCI as its gross and operating margins fell in recent quarters. In my analysis, I also constantly stress that it is crucial for investors to check whether a company's profitability is evolving in line with revenue. When profitability stagnates while revenue is growing, it could indicate that the business model is unsustainable.

I believe that is not the case for SMCI. First, the company is not a startup and has a long track record of strong financial performance, which means that management can manage growth efficiently over the long term. Second, SMCI faced a sharp increase in rack demand and the environment is rapidly evolving as Nvidia and AMD are in the fierce battle to launch the most powerful AI chip ever. Therefore, SMCI invested heavily in its infrastructure and capacity, R&D, and talent acquisition to address the rapidly evolving environment. I believe that these investments are very likely to pay off as the company is now well equipped to capitalize on the strong AI momentum.

Valuation update

SMCI is up 49% over the past twelve months and 45% year-to-date. Valuation ratios are high compared to historical averages and the sector median. On the other hand, SMCI has a strong exposure to AI, which is not incorporated in the historical averages. Also, not all companies in the sector have the same exposure to AI. Therefore, comparing SMCI’s multiples to the sector median and historical averages seems unfair in the current circumstances. Therefore, let me compare SMCI’s valuation ratios to other hot AI stocks like NVDA and AMD. They are not peers or competitors, but all three are perceived as big AI favorites.

Not only is SMCI cheaper than NVDA, it is also substantially cheaper compared to AMD, a company with revenue growth nowhere near that of SMCI. So, based on the valuation ratios, SMCI looks very cheap to me.

I consider the discounted cash flow [DCF] This approach is the most reliable for aggressive growth stocks. SMCI's total debt is negligible compared to its market capitalization. Therefore, I use the cost of capital as the discount rate. The cost of capital is calculated below using the CAPM formula. All assumptions for my CAPM calculations are publicly available on the internet.

Therefore, the model will be discounted using a discount rate of 10.72%. I am basing this on consensus revenue estimates, which are available for the entire next decade, which project a CAGR of 14.6%. On a TTM basis, SMCI’s FCF margin was negative due to heavy inventory investments to meet rising demand. Therefore, for the base year, I am incorporating a zero FCF margin. Adjusted EPS is expected to increase 52.3% in fiscal 2025 and 30.2% in fiscal 2026. Therefore, I believe that incorporating at least 100 basis points of annual expansion for the FCF margin is conservative enough.

With all these assumptions, my discounted cash flow model suggests that the fair value of the company is $95 billion. This is almost four times the current market capitalization, meaning the stock is once again as cheap as it was in December 2023.

Risk Update

My readers should know that SMCI's reputation is not perfect. In August 2020, the company paid SEC Fines $17.5 Million for alleged accounting violations. Recent report from Hindenburg Research Among other things, this included allegations of new cases of accounting manipulation. Market confidence deteriorated significantly, especially after SMCI announced that it would not be able to file its annual 10-K report on time the day after Hindenburg's report.

Even though SMCI has not had an official reaction from the company to Hindenburg's publication, I am quite skeptical of the report. Short sellers like Hindenburg are booking profits when stock prices plummet. So there is an apparent conflict of interest when such a company publishes its bearish report. Another reason I consider Hindenburg's report noise is that JPMorgan Chase (JPM) noted that it saw “limited evidence of accounting misconduct beyond reviewing the 2020 SEC charges, and limited new information regarding the existing and already known business relationship with related companies owned by the siblings of SMCI's founder.” I tend to believe the official comments of the largest US bank more than the report of a company with some conflict of interest.

Again, I do not recommend investing in SMCI if an investor is not willing to hold the stock for several years and is likely to panic if temporary declines occur. I have already mentioned that the SMCI's price range over the past year has been extremely wide and not everyone can handle such a roller coaster ride.

In summary

In conclusion, SMCI remains a “strong buy” for long-term investors who are comfortable with a substantial valuation. The company is firmly positioned and well equipped to ride the AI ​​wave, and the valuation is extremely attractive after the recent nosedive.