A saga all around The Super Micro Computer(NASDAQ: SMCI) continued to stock up on the news that the auditor had resigned. The stock has bounced like a ping-pong ball this year, with many extreme moves up and down. The stock is now down 9% year to date.
Let's take a closer look at some of the recent drama in the stock and see if we can decide whether the stock is a buy or just a no-go.
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The recent drop in Supermicro's stock is due to the resignation of the auditor, Ernst and Young, the accounting firm says it is “not willing to be associated with financial statements prepared by management.” It said its resignation was based on recent information, although in July it raised concerns about Supermicro's governance, transparency and internal controls.
For its part, Supermicro said it disagrees with Ernst and Young's assessment and does not expect to issue any statements in its financial reports. It is currently seeking another accounting firm to conduct its audit. This financial year was the first year Ernst and Young audited the company.
Supermicro's accounting came into public question back in August when the vendor Hindenburg Research accused the company of accounting fraud, as well as evading sanctions and managing dealings with related third parties. Its allegations were intended to help lower the stock price to its advantage, which it succeeded in doing. A short sale is when an investor borrows a stock from a current shareholder and then sells it immediately with the plan to buy it back later at a lower price.
Supermicro didn't do itself any favors when shortly after the brief report it decided to delay filing its 2024 fiscal year report with the Securities and Exchange Commission (SEC) to review “the design and effectiveness of its internal controls over financial reporting.” The Wall Street Journalon the other hand, he later reported that the company's accounting was being investigated by the Department of Justice (DOJ), which also caused a drop in Supermicro's stock.
Significantly, Ernst and Young's initial concerns came before the Hindenburg brief. This is also not the first time the company has encountered potential accounting problems. Back in 2020, the SEC fined Supermicro for early recognition of revenue and low costs, noting that employees were encouraged to ship products to warehouses at the end of the quarter, where it saw revenue even though the products had not yet reached customers. CEO Charles Liang was fined $2.1 million, but was not charged with wrongdoing.
Image source: Getty Images.
Although Supermicro has not been found guilty, there have been many negative allegations surrounding the company and it has a recent history of falsifying the books. Therefore, investors should consider this a very high risk.
At the same time, Supermicro is a real company that has benefited from the development of artificial intelligence (AI) infrastructure. It designs and assembles servers and rack solutions for customers and has carved a niche by being one of the first companies to adopt direct liquid cooling (DLC) in its setup. AI-powered servers consume a lot of power and generate a lot of heat and must be kept cool, and DLC seems like a solid solution.
Supermicro recently announced that it has shipped more than 100,000 graphics processing units (GPUs) with DLC solutions, and the company's products generally receive good reviews. However, this is a low-margin business, and the company saw margin pressure in its last quarter, fiscal Q4, when gross margin fell to 11.2% from 17% last year. By comparison, chipmakers are similar Nvidia again Broadcom have been generating gross margins of around 75%.
Although I don't think we've seen the last shoe drop when it comes to Supermicro and I don't think it's a good business, I think it's been a real beneficiary of AI development and that this is likely to continue. . At that point, the stock will be overpriced given the growth opportunities ahead, even if it has “smooth” quarterly results.
SMCI PE Chart (Forward 1y).
Overall, risk averse investors should stay away from the stock, which I personally would do. However, risk tolerant investors may consider taking a small position in the stock based on AI potential and valuation.
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Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool has positions and recommends Nvidia. The Motley Fool recommends Broadcom. The Motley Fool has a policy of disclosure.
Supermicro Shares Plunge Again. Time to Buy a Dip or Stay Away? was originally published by The Motley Fool
