Super Micro Computer’s Sales Growth Is Incredible, But It Could Be a Problem for the Stock

Super microcomputer (NASDAQ: SMCI) has been a hot buy this year, but lately the stock has been on a tear. In just six months, it’s down 27%. Its year-to-date return is still impressive at 90%, but it’s clear that investors are increasingly concerned that the stock could top out.

The company, also known as Supermicro, has seen strong growth driven by artificial intelligence (AI) as businesses upgrade their servers and IT infrastructure. Supermicro hasn’t just generated double-digit growth; its revenue more than doubled in the most recent quarter. However, revenue growth alone may not be enough of a catalyst to push the stock price much higher. While Supermicro is coming off another strong period of growth, there’s a more concerning number that investors may want to pay attention to: its gross profit.

Supermicro’s margins are shrinking

Sales growth is a good thing, but it’s not as important if a company’s cost of revenue is high. The higher those costs are, the less gross profit there is to cover overhead and operating costs. If margins aren’t good, that doesn’t necessarily translate into better results. That’s ultimately one of the main reasons investors are bullish on fast-growing companies: They assume they’ll generate bigger profits, which will improve their earnings multiples and can ultimately lead to a higher stock valuation.

But in the most recent quarter, which ended in June, Supermicro’s gross margin, which was already low at 17% a year ago, fell even lower, to just 11%. That means that for every dollar of revenue Supermicro generates, the company incurs $0.89 in costs. That revenue is before marketing and promotional expenses and before paying administrative staff; these are direct costs related to revenue.

This is not a new problem for Supermicro.

Supermicro’s business has not typically generated high margins. In normal times, they’re around 15%. But in the latest quarter, they hit a new low.

Whether a company generates margins of 11% or 15% doesn’t make a huge difference to investors, but it’s something to watch nonetheless. What could be a problem is if its overhead and other costs start to rise: Last quarter, Supermicro’s operating expenses were less than 5% of sales. If that percentage rises, it will compound the company’s low-margin problem. And if demand starts to slow as well, things could get worse quickly.

Supermicro’s revenue grew 143% to $5.3 billion, but its gross profit increased 60% to $596.3 million, and its operating income of $343.4 million increased 51%. Those numbers are still impressive, but the danger is that Supermicro’s growth rate will inevitably slow. Companies are unlikely to continue their spending spree on IT upgrades and servers. The AI ​​spending spree could slow next year, especially if a recession hits. And that…