Why Red Hat Shares Plunged

Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.

What: Shares of Red Hat (NYSE: RHT  ) dropped more than 12% during Tuesday's intraday trading after the open source enterprise computing solutions provider reported disappointing forward guidance following its second-quarter results.

So what: Quarterly revenue rose 16% year-over-year to $374 million, which translated to adjusted earnings per share of $0.35, up 25% from the year-ago period. For reference, those numbers actually exceeded analysts' expectations for adjusted earnings of $0.29 per share on sales of $372.11 million.

However, Red had also stated billings in the second quarter rose just 8% to $376 million, reflecting "modest IT spending in Europe and the impact of large deal arrangements."

Now what: To be sure, that was enough to spur downgrades from analysts at both Pacific Crest and Piper Jaffray, who worried the lower-than-expected billings could foretell slowing growth down the road.

With the stock currently trading at nearly 60 times last year's earnings and 30 times next year's estimates, today's drop looks merited if Red Hat can't prove to investors it will be able to grow into its lofty valuation over the long-term.

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