In this article, let's take a look at Red Hat, Inc. (RHT, Financial), a $12.55 billion market cap company, which is a leading provider of Linux operating systems for enterprises, and related middleware and virtualization software offerings.
Price Appreciation and Strong Results
Yesterday, the company saw its shares rise more than 10% on the day. The move comes amid the company reporting its financial results for the fourth quarter and full year fiscal 2014. Revenues rose by 16% to $464 million, beating estimates of 14% growth. Along with this, earnings per share increased in the fourth quarter compared to the same quarter a year ago ($0.43 vs $0.39). Now, considering the entire year, revenues rose by 17% to $1.78 billion, as expected by analysts, and earnings per share increased by 7% to $1.60, beating the estimate of $1.57.
Buyback Program
The North Carolina-based company announced a $500 million share buyback program, in order to replace the existing one, which was smaller and will expire at the end of the month and still had $80 million remaining. We believe that the new buyback program will add some value to its shares.
Margins and Profitability
With respect to the gross profit margin, it is currently high, at about 88%. Despite this, net profit margin of 10.29%, is similar to the industry average, and is ranked higher than 85% of the 2108 Companies in the Global Software - Application industry.
Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
| Ticker | Company | ROE (%) |
| RHT | Red Hat | 12.17 |
| NOW | ServiceNow Inc. | -43.92 |
| N | NetSuite Inc. | -45.37 |
| ORCL | Oracle Corporation | 23.03 |
| SYMC | Symantec Corp | 15.74 |
| Â | Industry Median | 6.71 |
The company has a current ROE of 12.17% which is higher than the industry median and also higher than the ones exhibit by Service Now (NOW, Financial) and NetSuite Inc. (N, Financial). In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. So for investors looking those levels or more, Symantec (SYMC) and Oracle (ORCL, Financial) could be the options. It is very important to understand this metric before investing and it is important to look at the trend in ROE over time.
| Year | ROE (%) |
| Feb-05 | 11.81 |
| Feb-06 | 19.02 |
| Feb-07 | 9.23 |
| Feb-08 | 8.65 |
| Feb-09 | 7.65 |
| Feb-10 | 7.87 |
| Feb-11 | 8.93 |
| Feb-12 | 10.90 |
| Feb-13 | 10.29 |
| Feb-14 | 11.61 |
Relative Valuation
In terms of valuation, the stock sells at a trailing P/E of 79.7x, trading at a premium compared to an average of 22.9x for the industry. To use another metric, its price-to-book ratio of 10.89x indicates a premium versus the industry average of 3.40x while the price-to-sales ratio of 8.32x is above the industry average of 2.64x.
As we can see in the next chart, the stock price has an upward trend in the five-year period. If you had invested $10,000 five years ago, today you could have $21,505, which represents a 16.6% compound annual growth rate (CAGR).
Final Comment
Although the firm faces strong competition from rivals such as IBM (IBM), Oracle (ORCL, Financial), EMC (EMC) and VMware (VMW), its exclusive business model will help it to maintain a key position in priority segments. We must mention that the firm has more than 60% of the Linux server OS market, which is great, because Linux OS had a good performance in the past years. Now, the company is the face of Linux.
After strong quarter results, I feel bullish on this stock. Further, hedge fund guru Jim Simons (Trades, Portfolio) bought 37,380 shares and Jeremy Grantham (Trades, Portfolio) has added the stock in the fourth quarter of 2014.
Disclosure: Omar Venerio holds no position in any stocks mentioned
