Ring Up Some Red Hat?

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Following Red Hat's (Nasdaq: RHAT) recent earnings announcement, I ventured to opine that the stock looked relatively cheap these days, despite SCO Group's clutzy attack on Linux, and despite the rough competitive field that features lumbering giants such as IBM (NYSE: IBM), Sun Microsystems (Nasdaq: SUNW), Novell (Nasdaq: NOVL), Hewlett-Packard (NYSE: HPQ), and Microsoft (Nasdaq: MSFT).

A few investors wrote to ask, "Hey, what's your target price?" Sorry folks, I can't give you one. But what I can point out is that recent events might suggest I'm not the only one who suspects that Red Hat's stock is behind its potential. Earlier this week, management at Red Hat announced a stock buyback in the amount of $100 million. There's no bigger vote of confidence in the stock than that, is there? Is there?

Well, I wouldn't go that far. While the press release does mention management's belief that the stock deserves to be higher, this buyback looks a lot more like damage control than anything else. Red Hat's pretty liberal with the stock options. (If expensed, last year's tally would have turned the $0.08 profit into a $0.36 loss!) This year's dilution runs above 7% with only two quarters in.

At today's prices, the $100 million buyback would take back just over half the shares that Red Hat doled out in the first six months of this year. One step forward, two steps back. The firm's free cash flow is decent, but if it's not enough to keep dilution in check, adjust your expectations accordingly. Keep an eye on the bottom line, and reread the 10-K's footnotes before you consider an investment in Red Hat.

For more Linux Foolishness:

• Beware the wrath of open source.
• Relive the recent drama of Red Hat's rundown.
• See what the resident Red Hat fans think on the Fool's discussion board.

Seth Jayson prefers his fast growers with a bit less dilution. At the time of publication, he had positions in no firm mentioned. View his stock holdings and Fool profile here. Fool rules are here.