Spotlight: How 1 AI Stock Soared 150%

Server infrastructure provider Super Micro Computer (NASDAQ:SMCI) has been among the tech stocks that have benefitted most from investor interest in artificial intelligence throughout 2023. The company’s model of using AI to provide superior server performance and reduce operating costs places it alongside companies such as Meta, NVIDIA and C3.ai on the list of investor favorites in the AI space.

With the stock up over 150 percent YTD, investors are understandably unsure of what the future holds for this highly volatile company. Let’s take the plunge to find out.

SMCI has seen its share prices soar for two separate reasons this year. The first is a general run on AI-focused stocks. Beginning with the successful rollout of ChatGPT late last year, companies specializing in artificial intelligence have seen their share prices soar as investors seek opportunities from the emerging technology.

SMCI also got an additional boost in May due to positive guidance for the coming quarter. Net sales are expected to total $1.7 billion to $1.9 billion, up from the $1.3 billion reported last quarter. Earnings are similarly expected to rise from $1.53 per share to up to $2.65 per share. Assuming SMCI can hit these lofty targets, the coming quarter’s results could continue to support the current share prices.

After this year’s massive run on the stock, SMCI is far from the attractive value proposition it once was. At 37.8 times its cash flow and nearly 7 times book value, SMCI is clearly priced on assumptions of high future growth. However, it may not be fair to say that the stock is significantly overvalued. The trailing P/E ratio for SMCI, for example, is 21.8. This is slightly lower than the S&P 500 average, which currently sits at 24.4. Assuming SMCI can deliver on its expected growth, the stock appears to be more or less fairly valued at today’s prices.

It’s also worth comparing SMCI to other AI stocks to get a sense of its valuation. When taking this view, SMCI appears to be far more reasonably priced than many of the other companies operating in the emerging AI space. NVIDIA, for instance, is priced at a multiple of nearly 130 to its cash flow. C3.ai, meanwhile, is priced at over 15 times sales and is still operating at a loss. While these companies appear significantly overvalued, SMCI has maintained a much more reasonable price point.

Although AI enthusiasm has certainly sent the stock on a run, SMCI’s upturn is largely justified by its underlying fundamentals. As such, it’s entirely possible that the stock could continue to rise if the company’s performance improves in future quarters.

Over the coming 12 months, analysts project earnings at SMCI to shrink by over 17 percent. While management’s forward guidance could indicate better times ahead, there are no guarantees that the company will be able to hit its own targets. On the 5-year horizon, however, earnings are projected to grow at a steady rate of 30 percent annually.

The company is also projected to continue increasing its sales, with 20-30 percent revenue growth rates expected over the next two years. As a provider of customized server infrastructure that can help companies reduce their energy expenses, SMCI is in a good position to maintain high levels of demand from its customers for several years to come.

Taking all of this into account, it seems likely that SMCI has ample potential to move higher on a multi-year time horizon, With the stock having nearly doubled this year, however, investors would likely be unwise to expect stable short-term gains. Run-ups such as the one SMCI has experienced rarely last, and they are often followed by equally drastic corrections.

While SMCI does not appear to have become overvalued in the way other AI stocks have, it is still susceptible to a correction. There is a substantial body of evidence to suggest that AI stocks are currently in a bubble, and SMCI would likely suffer if that bubble were to burst. The success of ChatGPT and moderately positive reports from companies such as NVIDIA have combined to send practically every AI-related stock surging this year. This surge has been compared to the dot-com bubble, and history suggests that the price run-up could be short-lived.

The possibility of a correction is also supported by analyst price forecasts for SMCI. The median 12-month price target for the stock is $167.50, implying a loss of 27.5 percent from the most recent price of $229.53. The massive range of price projections for the stock also suggests a nearly complete lack of consensus among analysts as to its true value. Price forecasts for SMCI run as low as $65 and as high as $400.

With that said, SMCI’s business fundamentals could prevent it from correcting as drastically as other AI stocks if and when the bubble bursts. Even with its earnings expected to fall over the coming year, SMCI is still generating positive cash flows for its investors. At nearly 35 percent, the company also boasts an excellent return on equity. The company has even managed to keep its debts extremely low, with a debt-to-equity ratio of just 0.08. These factors, paired with the company’s growth potential over the next several years, suggest that it is a high-quality business for investors to own.

In the short run, it seems probable that SMCI share prices will fall when the broader market for AI stocks eventually corrects. Although SMCI likely will not see its shares correct as much as substantially overvalued companies like NVIDIA and C3.ai, the stock will probably not be able to entirely escape the effects of an AI selloff.

In the long term, however, SMCI could be a good stock to hold. Given its roughly fair valuation and high probability of future growth, the company still has a great deal of potential for investors with a sufficiently long time horizon. If SMCI does fall due to an AI market correction, the selloff could present a buying opportunity for investors who are willing to buy and hold the stock for the quality and potential of its underlying business.