Briefing.com on RHAT ...
Red Hat (RHAT) 167 1/8 +23 3/8: Red Hat is a darling of the Linux investor crowd, or maybe the daytraders, but analyzing the business prospects of Red Hat gets very difficult very quickly. First of all, there are multiple Linux vendors. Second of all, you can get Linux for free. Lastly, there is valuation. Red Hat at this price is worth $11.5 billion, giving it a price/sales ratio of about 800 (TTM Revenue of $14.2 million). This is about as high as you ever see on a price/sales ratio. Frankly, we believe in Linux as a leading vendor of operating systems for web servers going into the future. But at this price, the expectations built into Linux sales are too tremendous to believe. Take just two minutes to do this simple calculation. At $100 per box (higher than the actual price), gross unit sales of Linux Red Hat would have to be 5 million units per year to give Red Hat $500 million in sales. At $500 million in sales, and a $11.5 billion market cap, they would have a price/sales ratio of 23, about what Microsoft's price/sales ratio is. In other words, if sales increased 50 times, but the stock price stays the same, the price/sales ratio would still only come down to that of the most powerful software company in the world. The biggest hype behind Linux is that it will topple the Microsoft world, first at the operating system level, then by being a platform for ASPs. But from a stock valuation point-of-view, Red Hat has already succeeded. From a risk/reward point-of-view, RHAT has more downside risk in it than upside potential. Sales might increase 50 times, but the stock price certainly won't. This puts us in the uncomfortable position of being very bullish on the company's business prospects, but very skeptical about the stock. We aren't alone in this viewpoint. Red Hat has just 0.17% institutional ownership, with 17 institutions owning 502,000 shares (Source: Vickers). That's an average of just 30,000 shares each. Red Hat is basically entirely in the hands of the public. As such, it is subject more to sentiment than any kind of business analysis. In fact, at $165 the stock could be ready for a split. When that happens, the stock might look cheap again at $50 a share, meaning an increase in demand. But now that it is disconnected from the underlying business, it has become as risky as your average bulletin board stock, since the price will trade on overall sentiment, not business trends. When this happens, there is really nothing left to analyze but investor sentiment, and that is best left to pure gamblers, not investors. - RVG
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