Buying Super Micro Computer Right Now Would Break Rule Number One

Long distance runaround

Long time waiting to feel the sound



I still remember the dream there



I still remember the time you said goodbye

-"Long Distance Runaround," Yes, 1971

No, not more lyrics. I bring up the stock, Super Micro Computer SMCI, where headlines both positive and negative have forced outsized volatility and it has been said that gamblers have as much of a shot at success as do traders and investors. 

On Monday, SMCI rallied and rallied hard, gaining 15.8% as the company announced that it had recently deployed more than 100,000 GPUs with its liquid cooling system for some of the largest AI factories as well as other cloud services providers.

The firm claims that its liquid cooling system reduces the power demands of its clientele by up to 40%. The system includes cold plates that allow liquid to flow through "microchannels" enabling up to 96 Nvidia NVDA B200 GPUs per rack with a cooling capacity of 250 kW with swappable pumps and power supplies.

The M1917 Browning belt-fed, water-cooled heavy machine gun this is not. Just a little more complex. Just as the Ma Deuce (M-2) was air cooled and ultimately replaced the M1917 as the U.S. heavy machine gun of choice, will there be an evolution here? I don't know that yet, but I do know the M-2 was America's main heavy machine gun by the end of WWII and still is, so there may be a better mousetrap out there.

Going Back

Early this year, Super Micro Computer was one of the AI craze darlings, running a rough 345% from early January to early March. Was that nuts? Sure. Things really got nuts after the apex of the share price, though. The stock was added to the S&P 500 and the Nasdaq 100. In early August, the firm announced a ten-for-one stock split with its June quarter financial results.

Then there was the Hindenburg Research report where Hindenburg revealed a short position in the stock. In fact, short interest in SMCI had been growing for months. CEO Charles Liang wrote to employees stating that Hindenburg's report and the information therein would prove false. Later in August, we learned that SMCI revealed that the firm would be unable to file its annual Form 10-K on time this year.

Is that all? Not even close. In late September, The Wall Street Journal reported that the Justice Department was in the early stages of investigating Super Micro Computer as an ex-employee had apparently filed a whistleblower suit against the company and Liang. The former employee, Bob Luong, made allegations related to transactions between the firm and companies run by Liang's relatives. Luong also alleged that Super Micro had fired employees associated with past accounting violations and then hired them back later. The U.S. attorney's office in San Francisco has been contacting individuals who could have relevant information in regard to this former employee's suit.

That's a Lot of Baggage

Whether one is prone to bet on or against this stock, this is a whole lot of baggage where the outcomes remain uncertain. That is quite a bit to overlook when putting valuable capital to work. The firm is expected to report in about three weeks. Wall Street is looking for an adjusted EPS of $0.74 on revenue of $6.45 billion. These numbers would be huge, as in earnings growth of 120% on revenue growth of 213%.

Seems awesome, right? Except that operating and free cash flows have been negative for three consecutive quarters. Oddly, for the June quarter, SMCI repurchased $2.339 billion worth of common stock, while issuing $3.515 billion in new debt. The balance sheet is as healthy as a horse if one looks at current and quick ratios alone. 

I don't love, however, when almost half of a firm's current assets are in inventories when the firm is on the cutting edge of new technology all of the time. How much of those inventories will hold their value? I honestly don't know. What are the margins on the latest products that seem vital to Nvidia?

Even With...

...the explosive growth in both earnings and sales, the stock trades at just 14.5-times forward-looking earnings. If the DoJ finds no fouls in their investigation and that annual 10-K gets filed and Hindenburg was blowing smoke (admittedly, a lot to ask for) then SMCI is inexpensive. If there are problems anywhere among the above "situation," then we have no idea. We do know that more than 19% of the float, as of September, was held in short positions. That's some nice kindling for a fire. We may have seen a bit of that on Monday.

The Charts

Readers will see that, through the second half of 2024, SMCI has found support close to the 78.6% Fibonacci retracement level of the late 2023 into March 2024 rally. Relative strength is close to neutral, but the daily MACD, though improved, still runs with two of its three components below the zero bound. Let's take another look.

Readers will see that if we impose an Andrews pitchfork model on SMCI since the share price peaked earlier this year, that the stock is currently trying to break out of the model's upper chamber and through the upper trendline. This will pit the shares up against their 50-day SMA, which will likely prove a more challenging test.

Typically, risk managers will allow portfolio managers to expand long-side exposure to various stocks if those stocks can take and hold either their 50-day or 200-day SMA. That said, with all of the above-mentioned baggage, risk managers may not permit portfolio managers to jump on board.

My Thoughts?

I am OK with a short-term trade as long as one understands what it is they are doing. What I will not do is invest on or against this name until we know more in regard to outcome. Am I chicken? I don't care what you call me. Risk management is rule number one when managing one's own capital.

At the time of publication, Guilfoyle was long NVDA equity.