The artificial intelligence (AI) revolution is in full swing, and the big winner of this revolution is Nvidia (NASDAQ: NVDA).
Well, that’s maybe the second biggest problem.
Nvidia is arguably the hottest company in the world right now. Its GPUs are in high demand as companies race to deploy AI. Nvidia was certainly the biggest winner in the popular “The Magnificent Seven” actions.
However, one AI beneficiary actually overtook Nvidia in the first half to take the overall lead S&P 500 hint.
Super Micro Computer takes advantage of Nvidia’s rise to become market leader
The best performing stock in the S&P 500 in the first half of the year was not Nvidia, but rather Super microcomputer (NASDAQ: SMCI). Supermicro returned an impressive 188% in the first half of the year, compared to just 150% for Nvidia, including dividends. Moreover, while Nvidia ended the quarter near its year-to-date highs, Supermicro was actually significantly higher at the start of the half, reaching a year-to-date gain as large as 331% at one point in mid-March!
How did Supermicro pull it off? In fact, it’s for the same reasons that Nvidia has continued to take off: explosive growth driven by artificial intelligence. In fact, you could argue that Supermicro, as a server maker, rode Nvidia’s growth wave because demand for Supermicro’s AI-powered servers, which account for over 50% of its revenue and primarily feature Nvidia GPUs, took off. So Supermicro’s AI-powered growth was likely driven primarily by reselling Nvidia chips, with a small margin, as indicated by Supermicro’s relatively low gross margins of 15.5% last quarter.
Nvidia also posted higher revenue growth than Supermicro, with 262% growth in the second quarter, compared to “only” 200% growth for Super Micro Computer last quarter.
But as we’ve seen, the correlation between financial results and stock markets isn’t always perfect. Has Supermicro stock achieved such a feat?
From a lower valuation
While a company’s long-term performance is the key determinant of its long-term performance, valuation is also important, especially in the short term. As we can see, Supermicro was starting from a much lower valuation this year.
On January 1, Supermicro was worth about 25 times earnings, while Nvidia was worth 65 times earnings. Yet during the quarter, Supermicro’s valuation increased to about 45 times earnings, an increase of 80%, while Nvidia’s price-to-earnings ratio increased to 72, a mere 8% increase.
At the same time, both companies have seen their forward earnings estimates rise by roughly the same amount over the first half, with each stock seeing its one-year forward earnings estimates from Wall Street analysts rise by about 80% to 90%.
Earnings estimates were revised up due to the stellar results and expectations from both companies during the quarter. Supermicro’s estimates were boosted significantly earlier this year when the company significantly raised its guidance on its February earnings call. And while earnings estimates continued to rise even after its May 1 earnings report, the stock fell. That may have been because the previous quarter set the bar for expectations so high.
Meanwhile, Nvidia continued to surge, with its stellar growth in February and May continuing to defy skeptics. However, with the company already suffering from high expectations at the start of the year, it didn’t bounce back as much after its February results, leaving “room” for surprise after its May results.
So, Supermicro’s outperformance largely depends on initial expectations.
Evaluation is important
Trying to learn from this is a bit of a hair-splitting exercise, because both stocks have outperformed by a wide margin, and for the same reasons. However, there is one lesson to be learned: Valuation matters. If a company is great but already trading at a high valuation, its value may not grow as much as a company that may not be as good but is able to outperform expectations to a greater extent.
Think of it like a point spread in football. Stock market valuations are essentially “point spreads” on stocks. You only win a bet if your team wins the game. And beats the point spread. Similarly, if your team loses but by a smaller margin than the others think, you still win the bet.
Phil Fisher, one of the greatest growth investors of all time, once said, “Every significant movement in the price of an individual common stock relative to stocks as a whole occurs because of a change in the financial community’s valuation of that stock.”
As enthusiasm for AI grows and many tech stocks reach sky-high valuations, this is something to keep in mind as expectations appear to be rising for AI winners this year.
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Billy Duberstein and/or its clients’ positions in Super Micro Computer and has the following options: short January 2025 $1,840 calls on Super Micro Computer, short January 2025 $110 puts on Super Micro Computer, short January 2025 $125 puts on Super Micro Computer, short January 2025 $130 puts on Super Micro Computer, short January 2025 $280 calls on Super Micro Computer, and short January 2025 $85 puts on Super Micro Computer. The Motley Fool has a position in Nvidia and recommends the company. The Motley Fool has a position in Nvidia and recommends the company. disclosure policy.
How This Chip Company Outperformed Nvidia in the First Half was originally published by The Motley Fool
