Highly sophisticated semiconductor chips, so-called graphics processing units (GPUs), play an important role in the development of artificial intelligence (AI).

What some investors may not know, however, is that chip designers like NVIDIA And Advanced micro devices are highly dependent on external parties for chip distribution.

The increasing demand for chips was an indicator of increased capital expenditure (Capex) in areas such as data center infrastructure. Here Super-microcomputer (SMCI -2.04%)a specialist in server racks and device architecture, comes into play.

But despite the company’s crucial role in the AI ​​space, shares of Supermicro, as the company is also known, have fallen by just over 30% in the past three months.

Let’s examine what’s driving some of the selling activity and assess why now seems like a fantastic time to buy on dips in Supermicro stock.

A look under the hood

There are several key reasons for Supermicro’s recent sell-off.

First, the macroeconomic outlook is mixed. Combined with inflation, July’s reading of 2.9% represents a three-year low. While encouraging, it is still above the Federal Reserve’s long-term target of 2%, and mixed jobs reports have made investors cautious. The general market sentiment has driven selling activity in many stocks this summer.

At the corporate level, Supermicro generated revenue of $5.3 billion in the fourth quarter of fiscal 2024 (ended June 30), up 141% year over year. As you can see below, demand trends are strong for Supermicro. However, a look further down the income statement paints a different picture.

Data from YCharts.

In the same quarter, gross margin fell to 11.2% from 17.0% a year ago. Operating margin also shrank by about 390 basis points to 6.5%. So while revenues have risen sharply since the beginning of last year thanks to booming interest in AI, Supermicro’s profitability has moved in the opposite direction.

In other words, rising sales and falling profitability metrics suggest that the company is paying a high price for its new growth. A deterioration in the margin profile can have a negative impact on cash flow and liquidity.

Given this turbulent financial profile, I’m not surprised that some investors are no longer buying the stock. Still, I wouldn’t panic just yet.

Image source: Getty Images.

Why the sell-off seems exaggerated

Management addressed the challenges related to the company’s margins during the company’s last earnings call.

Essentially, supply and demand dynamics in the AI ​​space are currently under a lot of pressure. This can lead to unpredictable lead times when it comes to the cost of products, shipping, and more. For these reasons, some companies are experiencing abnormal costs due to ongoing supply chain bottlenecks that are disproportionate to revenue trends in a given quarter.

CFO David Weigand tried to allay these concerns:

We expect gross and operating margins to increase gradually throughout the year, driven by product and customer mix, production efficiencies on new … AI GPU clusters, and the launch of new platforms. As (CEO Charles Liang) explained, supplies in the near term may continue to be constrained by supply chain bottlenecks for key new components for advanced platforms. However, gross margins in the long term will benefit from lower production costs as we increase production in Malaysia and Taiwan, in addition to expanding in the Americas and Europe.

Weigand’s explanation makes perfect sense. As manufacturing capacity becomes more efficient through new production centers in Asia, Europe and North America, Supermicro should begin to achieve a more normalized relationship between revenue and cost growth. This, in turn, will improve the company’s profitability metrics over time.

Why now is a good time to invest in Supermicro

Supermicro currently trades at a price-to-earnings (P/E) ratio of 31.3. That’s a bit expensive even for a growth stock, but on a P/E basis, shares are well below their previous highs.

Data from YCharts.

An investment in Supermicro should be based on two fundamental ideas. First, you should have a strong belief in AI and its ability to continue to deliver impressive revenue growth to the company. But more importantly, you should be focused on the company’s path to improved profitability.

Considering Supermicro’s position in the IT infrastructure landscape and the continued tailwind for AI, the company seems to have a recipe for success.

Long-term investors should seriously consider taking advantage of Super Micro Computer’s recent sell-off and relatively low valuation. It shouldn’t be long before the company shows improvement in its margins, and if it does, the stock could easily rally back to its previous highs.