After the market closed yesterday, Red Hat reported a year-over-year increase in fourth-quarter revenue of 43% (and an 11% increase from the third quarter). Net income increased from break-even in the prior fourth quarter to a $5 million profit this time around.
The growth explains the interest investors are showing in the stock. But what explains the rabid nature of that interest (the stock is trading at 270 times trailing earnings) can be seen in the cash flow statement. Net cash provided by operations grew for the year to $61.1 million from break-even the prior year. That means Red Hat was also free cash flow positive for the year, despite capital expenditures almost doubling. Bravo.
The company has finally turned the corner and reached a size where it can become a cash-generating engine. Add in that Red Hat has $941.3 million in cash and investments, and its staying power is not in question either.
With IBM (NYSE: IBM ) , Dell (Nasdaq: DELL ) , and Hewlett-Packard (NYSE: HPQ ) offering Red Hat's product to its customers, and gross margins at the record level of 76% overall (and 91% for enterprise subscriptions), it would seem that everything is in Red Hat's favor -- or is it?
The company had sales for the last fiscal year of $68.9 million and a market capitalization of $3.8 billion. That means the stock is trading for a whopping 55 times sales. The most optimistic analyst is predicting earnings two years out of $0.48 a share -- which, at today's price, is 45 times earnings. To say the least, the market has priced lots of good news, and then some, into Red Hat.
It is not like this is anotherTaser (Nasdaq: TASR ) , where having no competition has met with exploding sales and a rocketing stock price. There's also Novell (Nasdaq: NOVL ) and its new agreement with IBM for enterprise servers. There is also the threat that SCO Group (Nasdaq: SCOX ) might win its suit claiming it is owed licensing fees because Linux software contains SCO's UNIX code.
There is no doubt that Red Hat is experiencing excellent growth, especially in cash flow. But given the stock's price, and its growth potential, there is too much good news priced into the stock to make it anything but an extremely risky investment.
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Fool contributorW.D. Crottydoes not own any of the stocks mentioned. W.D. is an information technology consultant, and even with his inside view, he has not purchased any of the operating system stocks.