Stock splits are usually good indicators of strength, since companies normally only split their stock after the price of an individual share has gotten expensive. Super Micro Computer's (NASDAQ: SMCI) 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 around 32%. There are a few reasons for this, but I don't think any of them justify avoiding the stock as a long-term investment -- although investors must be aware of the risk they are taking on.
Supermicro's products are in high demand
Super Micro Computer manufactures components for data centers and builds full servers. This was a good business in recent years, and it has been a phenomenal business lately. Thanks to unprecedented artificial intelligence (AI) demand, companies are rushing to expand their computing capacity. This has caused businesses like Supermicro's to boom because it is a key supplier in this space.
While it has many competitors, none offer a solution that is as customized as Supermicro's for a full server. And its liquid-cooled technology offers clients the most energy-efficient server available, which saves on 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 done so well this year.
But there is more to Supermicro's investment thesis than its best-in-class products.
Two factors are causing the stock to struggle in the short term
Since the stock peaked in March this year, it has steadily declined. Part of this decline is warranted since the expectations priced into the stock at that time were unrealistic. However, the levels it has fallen to are too cheap, creating an exciting investment opportunity.
The causes of the most recent stock drop following its earnings report for its fourth quarter (ending June 30) are twofold. First, Supermicro's gross margins have declined for many quarters.
This isn't a great sign -- declining gross margins can indicate that Supermicro's products are becoming commoditized and that it's losing 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 throughout fiscal 2025 and return to historical norms over the long term.
Regardless, this will hurt profits in the short term, which investors don't want to see. This caused the initial stock decline following earnings.
The second reason for the decline involves Hindenburg Research, a famed short-selling firm that benefits when stock prices drop. Hindenburg released a short-seller report alleging accounting malpractice by Supermicro, something that the company has already been fined for by the Securities and Exchange Commission (SEC).
To make matters worse, Supermicro has delayed filing its end-of-year form 10-K with the SEC because, management said, it is assessing the "design and operating effectiveness of its internal controls over financial reporting." If you can't trust the financials a company is reporting, the stock becomes unworthy of an investment, which is why many dumped the stock following the report.
But the company doesn't expect any changes to its financial results. So this could be a wake-up call for management to get its business in order, and will likely not be a factor in the long term, assuming its financials don't change and the Hindenburg report turns out inaccurate.
That isn't the end of the Hindenburg saga, however. Shortly after the Hindenburg report, the U.S. Department of Justice opened at probe into Supermicro. This probe might come up with nothing. Still, there is a possibility that it could lead to further action, so the risk of investing in Supermicro has increased. Investors have a long time to wait until the results of this investigation are known.
Meanwhile, these two short-term factors driving the stock down have opened up a long-term investment opportunity if it turns out that the company isn't found to have engaged in accounting malpractice. This can be seen in its forward price-to-earnings ratio (P/E), as the stock trades for a dirt-cheap 12 times forward earnings.
That's cheap for any stock, let alone one set to grow its revenue between 74% and 101% in fiscal 2025. Couple that with steadily improving margins, and you have a recipe for a stock that could have a strong year once other questions are sorted out.
I think Supermicro's stock could soar after its split. Multiple short-term factors are dragging it down, but should those be resolved favorably, Supermicro is primed to post excellent returns thanks to the massive demand for its products.
For now, there is an increased risk of investing in Supermicro due to an ongoing government probe. This shouldn't cause you to ignore the stock completely, assuming you're willing to take the risk, but it should guide your position sizing if you choose to invest in the stock sometime soon.
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Keithen Drury has positions in Super Micro Computer. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
One Stock That Could Soar After Its Oct. 1 Split was originally published by The Motley Fool