Open Source Software Leader, Red Hat, Inc. – Time to Buy?

Case Background: Red Hat, Inc. (RHAT) is an open source solution provider of Linux. Currently, the company shares trade on the NASDAQ, but it will begin trading on the NYSE on December 12, 2006, under the ticker symbol, RHT. Red Hat, Inc. provides operating system platforms, middleware, applications, and management solutions. The majority of revenue is derived from support, training, and consulting services. Based in Raleigh, North Carolina, there are 51 office locations worldwide and 1,150 employees. The greatest threat to Red Hat, Inc. is Microsoft, Inc. (MSFT) and its Windows-based operating system. Novell, Inc. (NOVL) provides services similar to Red Hat, Inc., but is not the market leader in Linux open source solutions. Novel, Inc. distributes a similar Linux open source operating system: Suse Linux. Discussion: Until recently, Microsoft, Inc. has threatened to file patent infringement charges against Linux users. On November 3, 2006, Microsoft, Inc. announced a “patent covenant” with Red Hat, Inc.’s competitor, Novel, Inc., in which both companies agree not to file patent infringement charges against users of rival software: Suse Linux and Microsoft Windows.

This agreement will be valid through 2012. This move puts pressure on Red Hat, Inc. since its largest rivals, Microsoft, Inc. and Novel, Inc., have a patent covenant. This maneuver by Microsoft, Inc. is an attack on its largest Linux competitor. It is an attempt to ensure that Windows remains the dominant operating system for both consumers and businesses.

Conclusion:
Red Hat, Inc.’s move to the NYSE is an attempt to differentiate itself from other NASDAQ bellwether companies. Currently, it is trading at $16.98 per share, with a P/E ratio of 44.97. The stock’s future 1-year P/E ratio is estimated to be 28.33 – 35.87. Investors wanting to invest in an open source solutions provider should use this opportunity to purchase Red Hat, Inc. The stock price is trading near its 52-week low of $13.70 per share.

Disclaimer:
P/E ratios are a quick way to sort out the leaders within the same sector. Never use a P/E ratio exclusively to make an investment. Remember, a P/E ratio is measured using historical trailing earnings for the previous 12 months and does not necessarily indicate strong future earnings. P/E ratios, when used with other market value ratios, can help investors to make consistent returns and to minimize losses. Various interpretations of a particular P/E ratio are possible:

1. 0-13 - Either the stock is undervalued or the company's earnings are thought to be in decline.
2. 14-20 - For many companies, a P/E ratio in this range may be considered fair value.
   
   • The average U.S. equity P/E ratio is usually around 14, which means it takes about 14 years for a company's stock to earn back its full purchase price.
   • Average P/E over the entire market is a good indicator of overall market strength.
3. 21-28 - Either the stock is overvalued or the company's earnings have increased since the last earnings figure was published.
4. 28+ - A company whose shares have a very high P/E ratio either really does have an exceptionally rosy future or the stock may be the subject of a speculative bubble.
5. A company with no earnings has an undefined P/E ratio.
   

Financial information was provided by http://finance.yahoo.com (11/21/2006) This investment article was edited by http://www.proof-reading.com; copyright © 2006 PE-Ratio.com. All rights reserved.