Berkshire Hathaway's huge milestone; A look at earnings from Five Below and Nvidia; Warning signs for Super Micro Computer

1) Warren Buffett's 94th birthday is tomorrow, and the market just gave him an early birthday present...

Yesterday, the A-class shares of Berkshire Hathaway (BRK-A) closed at $696,502, and the B-class shares (BRK-B) closed at $464.59. That made Berkshire the first nontech company to surpass a $1 trillion market cap.

The other six U.S. companies in this $1 trillion-plus group are: Apple (AAPL), Nvidia (NVDA), Microsoft (MSFT), Alphabet (GOOGL), Amazon (AMZN), and Meta Platforms (META).

Through yesterday's close, BRK-B shares are up 30% this year – handily outperforming the S&P 500 Index's 17% return.

I've been bullish on Berkshire for years – at various points, calling it "America's No. 1 Legacy Stock" or "America's No. 1 Retirement Stock." But as it has risen, I've been tempering expectations...

In my August 5 e-mail, after Berkshire reported second-quarter earnings and disclosed that Buffett had sold half its stake in Apple, I concluded that:

Berkshire is only slightly undervalued today, but it remains the safest large-cap company in the world and continues to grow strongly... so investors should be very comfortable continuing to hold the stock.

Today, with the stock up another 12% in the three weeks since then, I would say that the stock isn't undervalued at all.

To echo what Buffett wrote in his 2023 annual letter, released in February: "we have no possibility of eye-popping performance."

I don't think Berkshire is overvalued at these levels – I simply think it will perform in line with the S&P 500, rather than drastically outperform it, for perhaps the next three to five years.

2) As I've been writing for quite some time, rather than constantly chasing the most popular large-cap stocks like Berkshire and Nvidia (discussed below), I think investors will do better if they can identify beaten-down stocks of quality companies that are poised for a turnaround.

One such stock is discount retailer Five Below (FIVE), which I analyzed in my July 22 and July 23 e-mails...

The stock popped as much as 6% this morning before pulling back after the company reported better-than-feared second-quarter earnings yesterday.

I say "better than feared" rather than "better than expected" because after Five Below missed expectations the past two quarters and the CEO resigned a month ago, investors feared another big miss.

But reporting results and giving guidance that were merely bad – but not catastrophic – caused the relief rally in the beaten-down stock instead of sending it plummeting.

3) The earnings report everyone was focused on yesterday was from Nvidia, which reported another stunning quarter...

Revenue soared 15% from the previous quarter and 122% year over year, while adjusted earnings per share jumped 11% and 152%, respectively. The company also gave strong guidance for the third quarter, with revenue expected to grow 8% sequentially.

So why is the stock down today?

Because, unlike for Five Below, expectations – and the valuation – were sky high.

Analysts expect Nvidia to generate $122 billion of revenue and earn $2.75 per share this year (ending January 2025), which means that today, with a roughly $3 trillion market cap (nearly 3 times that of Berkshire!), it's trading at about 25 times revenue and about 45 times earnings.

Those are nosebleed valuations, especially when the year-over-year comparisons are going to get much more difficult going forward after such explosive growth – which you can see in this chart of revenue and net income over the past 14 quarters:

Nvidia is a great company, and it may do very well going forward. But this is the kind of stock I like to pound the table on when it's down at least 50% (if not 75%).

Think it can't happen? Look at the five-year performance chart of Meta and Netflix (NFLX) below – both stocks dropped more than 75% from late 2021 to late 2022, giving investors extraordinary buying opportunities (I was pounding the table on both of them):

4) Meanwhile, I'm highly wary of Super Micro Computer (SMCI), which makes servers that contain chips made by Nvidia and others.

SMCI has also been riding the AI boom, but the stock looks like it is now busting. Take a look at its wild ride over the past year:

On Tuesday, renowned activist short seller Nate Anderson of Hindenburg Research released this damning report on the company: Super Micro: Fresh Evidence Of Accounting Manipulation, Sibling Self-Dealing And Sanctions Evasion At This AI High Flyer. Excerpt:

• Super Micro Computer Inc. is a $35 billion server maker based in Silicon Valley, California that has ridden the wave of AI enthusiasm.
• Our 3-month investigation, which included interviews with former senior employees and industry experts as well as a review of litigation records, international corporate and customs records, found glaring accounting red flags, evidence of undisclosed related party transactions, sanctions and export control failures, and customer issues.
• In 2018, Super Micro was temporarily delisted from Nasdaq for failing to file financial statements. By August 2020, the company was charged by the SEC for "widespread accounting violations," mainly related to $200+ million in improperly recognized revenue and understated expenses, resulting in artificially elevated sales, earnings and profit margins.
• Less than 3 months after paying a $17.5 million SEC settlement, Super Micro began re-hiring top executives that were directly involved in the accounting scandal, per litigation records and interviews with former employees.
• A former salesperson told us: "Almost all of them are back. Almost all of the people that were let go that were the cause of this malfeasance."
• According to a lawsuit filed in April 2024, Super Micro waited only 3 months after the SEC settlement before restarting "improper revenue recognition," "recognizing incomplete sales," and "circumvention of internal accounting controls".
• Even after the SEC settlement, pressure to meet quotas pushed salespeople to stuff the channel with distributors using "partial shipments" or by shipping defective products around quarter-end, per our interviews with former employees and customers.

Given Anderson's reputation and track record – most famously exposing the fraud at Nikola (NKLA) – the depth of his research, and the seriousness of his charges, I'm shocked that the stock only declined 2.6% on Tuesday.

But then yesterday, the stock crashed 19% after the company announced that it wouldn't be filing its annual 10-K on time. Here's an excerpt from the press release:

SMCI is unable to file its Annual Report within the prescribed time period without unreasonable effort or expense. Additional time is needed for SMCI's management to complete its assessment of the design and operating effectiveness of its internal controls over financial reporting as of June 30, 2024.

Is it a coincidence? I'm not so sure...

There's a possibility that the delay is because the board and/or auditors aren't willing to take the risk of signing off on SMCI's numbers without thoroughly investigating what Anderson has uncovered.

Will he be proved correct that the company is once again cooking the books? Based on a quick look at SMCI's income and cash-flow statements, I suspect Anderson might be on to something...

Normally, these two statements move in the same direction: If a company is reporting growing sales and profits, its operating cash flows should also be growing.

For example, here's Nvidia's operating cash flow over the same time period (the past 14 quarters) as the earlier chart with revenue and net income:

This is exactly what I would expect to see – the cash-flow statement closely tracks the income statement.

Now, let's look at SMCI.

Here's a chart of the company's revenue and net income over the past 14 quarters – showing the explosive growth that drove the stock price:

But look at operating cash flow:

Put simply, that's just weird.

And it's hard to pin down exactly what's causing it because the company failed to include a full cash-flow statement – another red flag – when it reported earnings results earlier this month. SMCI reported a detailed income statement and balance sheet, but just this summary cash-flow statement:

When a company is engaging in aggressive sales tactics like stuffing the channel and booking sales before they actually occur, it shows up in ballooning accounts receivables and inventories that, in turn, reduce operating cash flows.

When it comes to SMCI, last year the company grew revenues 110%... but accounts receivables and inventories grew 132% and 205%, respectively – as you can see here from the same earnings release:

Based on this quick analysis and many similar situations I've seen over the years, I think there's a chance that SMCI will be forced to admit that, once again, it was cooking its books and will have to restate its financials.

Of course, we'll have to wait and see what comes of all this. But if Anderson is correct and SMCI comes clean, the stock, which has a roughly $27 billion market cap and trades at about 22 times trailing earnings, would have much further to fall...

Best regards,

Whitney

P.S. If you've been following along with my e-mails this week, you'll know I covered the first part of my analysis of Southwest Airlines (LUV) yesterday. I haven't forgotten about the next part of it... so stay tuned for tomorrow!

P.P.S. I welcome your feedback – send me an e-mail by clicking here.