The artificial intelligence (AI) revolution is in full swing, and the big winner of that revolution is Nvidia (NASDAQ: NVDA).
Well, it’s probably the second biggest.
Nvidia is arguably the most focused company in the world right now. Its GPUs are in high demand as companies race to deploy AI. Of course, Nvidia has been the biggest winner of the popular “Magnificent Seven” stock.
However, one AI beneficiary actually overtook Nvidia in the first half to lead everyone S&P 500 index.
Super Micro Computer drives Nvidia’s coattails to lead the market
The best-performing stock in the S&P 500 in the first half of the year wasn’t Nvidia, but rather Super Micro Computer (NASDAQ: SMCI). Supermicro returned 188% in the first half of the year, compared to just 150% for Nvidia, including dividends. Not only that, but while Nvidia finished the quarter near year-ago highs, Supermicro was actually significantly higher at the start of the half, posting a year-to-date gain of up to 331% at one point in the middle of March!
How did Supermicro pull it off? It’s actually for the same reasons that Nvidia continued to rise: the explosive growth associated with artificial intelligence. In fact, it could be said that Supermicro, as a server manufacturer, rode a wave of growth on Nvidia’s back, as demand for Supermicro’s AI servers, which account for over 50% of its revenue and mostly feature GPUs Nvidia, stepped up. So Supermicro’s AI-driven growth is likely due to the resale of Nvidia chips, with a small increase, indicated by Supermicro’s relatively low gross margins last quarter of 15.5%.
Nvidia also posted higher revenue growth than Supermicro, with 262% growth in the second quarter, versus “only” 200% growth for Super Micro Computer last quarter.
However, the stock market is not always exactly related to financial results, as we have seen. So has Supermicro stock now managed to achieve such a feat?
Starting from a lower estimate
While long-term business performance is the primary determinant of long-term performance, valuation also matters, especially in the short term. And as we can see, Supermicro was starting from a much lower valuation this year.
On January 1, Supermicro was trading at about 25 times earnings, while Nvidia was trading at 65 times earnings. However, during the quarter, Supermicro’s valuation expanded to about 45 times earnings—an increase of 80%—while Nvidia’s P/E ratio expanded to 72—an increase of just 8%.
Meanwhile, both companies saw their forward earnings estimates rise, and by roughly the same amount during the first half, with each stock seeing Wall Street analysts’ forward earnings estimates one year rise by about 80% to 90%.
Earnings estimate increases were driven by stellar earnings and expectations from both companies during the quarter. Supermicro’s valuations got a big boost earlier in the year when it greatly increased its forward guidance in its February earnings call. And as earnings estimates continued to rise even after the May 1 earnings report, the stock sold off. That was probably because the previous quarter set such a high bar of expectations.
Meanwhile, Nvidia continued to rise as the fiery growth it posted in February and May continued to defy skeptics. However, since the company was already suffering from high expectations coming into the year, it did not rise as much after February’s earnings, leaving “room” to surprise after May’s earnings.
Thus, the high performance from Supermicro mainly comes down to initial expectations.
Rating matters
Trying to parse any lessons here is really splitting hairs, as both stocks have outperformed, and for the same reasons. However, one lesson to be learned is that evaluation matters. If a company is a great company but already trades at a high valuation, it may not grow as much as a company that may not be as great but is able to beat initial expectations to a greater degree. great.
Think of it like a point spread in football. Market valuations are essentially the “spread” on stocks. You only win a bet if your team wins the game AND beat point spread. Similarly, if your team loses, but by less than others think, you still win the bet.
One of the greatest growth investors of all time, Phil Fisher, once said: “Any significant movement in the price of any individual common stock relative to the stock as a whole is due to a changed valuation of that stock by financial community”.
As AI excitement takes hold and many tech stocks soar to sky-high valuations, this is something to keep in mind as expectations seem to have grown ever higher for this year’s AI winners.
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Billy Duberstein and/or his clients take positions on Super Micro Computer and have the following options: short calls Jan 2025 $1,840 Super Micro Computer Feb $110 Jan 2025 Super Micro Computer Feb $125 Jan 2025 Short Jan 2025 $130 on Super Micro Computer, short Jan 2025 $280 on Super Micro Computer and Feb $85 on Jan 2025 on Super Micro Computer. The Motley Fool has positions and recommends Nvidia. The Motley Fool has a disclosure policy.
How this chip company outperformed Nvidia in the first half was originally published by The Motley Fool