Red Hat (RHT): I Buy

This morning I bought some Red Hat (RHT). I believe the stock is undervalued, the company is growing rapidly, and in addition this helped diversify my portfolio.

I have watched Red Hat for over a decade, and in a way it is responsible for my being a technology stock analyst and investor today (I warned against buying its stock back then). Red Hat went public in 1999 (See Wikipedia Red Hat article for more history). It was touted as another "next Microsoft." A leader in the commercialization of the "open-source" Linux operating system, the stock flew near the sun despite having tiny revenues and no profits. Along with many Internet related stocks its price crashed in 2000-2001 (See chart.) The stock price is up quite a bit since then, but is only about 1/20th of its peak price in 1999.

Red Hat is now a profitable, rapidly growing company, with reported Q3 revenues of $135.4 million, up 6% sequentially from $127.3 million and up 28% from $105.8 million year-earlier. [That would be their Q3 fiscal 2008, ending November 30, 2007]. See my full summary of the Red Hat December 20, 2007 analyst conference for a wealth of detail.

Like all stocks, buying Red Hat is risky. In Red Hat's case there is an increasing amount of competition in the Linux space. Novell is staking its future on Linux; IBM, and Oracle offer Linux, and Sun Microsystems offers Solaris in direct competition.

Red Hat has been in the Linux business a long time and has a large installed base and a sterling reputation as a service provider. It is still growing on a small base. It has introduced new services like JBoss and virtualization.

It also has a low P/E ratio for a growth stock. GAAP earnings in the latest quarter were $0.10 per share. That would annualize to $0.40. At $17.90 per share that would be a P/E of 45. But a broker trying to get a commission by selling shares would use non-GAAP earnings to get the P/E. Non-GAAP earnings were $0.19 per share, annualizing to $0.76, and giving a P/E of 24.

I believe Red Hat is likely to grow earnings faster than revenues, given their business model and the fact that it has been happening lately. I also believe Red Hat won't be hurt much by macroeconomic weakness because the main thing it is selling is a value proposition to its customers: Red Hat Linux lowers operating costs comparted to UNIX or Windows (which, of course, Microsoft disputes).

Well I could be wrong, but I think it is a good bet.

Keep diversified.

For more data see:

My Red Hat main page
NASDAQ Red Hat summary page