Benjamin Graham taught that Intelligent Investors must do a thorough fundamental analysis of investment opportunities to determine their intrinsic value and inherent risk. Â This isÂ best done by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another companyÂ or by reviewingÂ 5 Undervalued Companies for the Enterprising Investor.Â By using theÂ ModernGraham methodÂ one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries. Â What follows is a specific look at how Red Hat Inc. (RHT) fares in theÂ ModernGraham valuation model. Company ProfileÂ (obtained fromÂ Google Finance):Â Red Hat, Inc. (Red Hat) is a global provider of open source software solutions, using a community-powered approach to develop and offer operating system, middleware, virtualization, storage and cloud technologies. The Company offerings include Red Hat Enterprise Linux, Red Hat JBoss Middleware, Red Hat Enterprise Virtualization and Red Hat Storage Server. Red Hat Enterprise Linux is an operating system, which runs on a range of hardware, including mainframes, servers and work stations. Red Hat JBoss Middleware is a range of technologies used for developing, deploying and managing distributed applications. Red Hat Enterprise Virtualization includes standalone virtualization functionality and management tools for both server and desktop deployments. Red Hat Storage Server is software, which enables users to treat storage as a virtualized resource, and is available for deployment both on-premise and in public or hybrid clouds.
Defensive Investor – must pass at least 6 of the following 7 tests: Score = 3/7
- Adequate Size of Enterprise – market capitalization of at least $2 billion – PASS
- Sufficiently Strong Financial Condition – current ratio greater than 2 – FAIL
- Earnings Stability – positive earnings per share for at least 10 straight years – PASS
- Dividend Record – has paid a dividend for at least 10 straight years – FAIL
- Earnings Growth – earnings per share has increased by at least 1/3 over the last 10 years using 3 year averages at beginning and end of period – PASS
- Moderate PEmg ratio – PEmg is less than 20 – FAIL
- Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 – FAIL
Enterprising Investor – must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 3/5
- Sufficiently Strong Financial Condition, Part 1 – current ratio greater than 1.5 – FAIL
- Sufficiently Strong Financial Condition, Part 2 – Debt to Net Current Assets ratio less than 1.1 – PASS
- Earnings Stability – positive earnings per share for at least 5 years – PASS
- Dividend Record – currently pays a dividend – PASS
- Earnings growth – EPSmg greater than 5 years ago – FAIL
Valuation Summary Key Data:
|Value Based on 3% Growth||$13.27|
|Value Based on 0% Growth||$7.78|
|Market Implied Growth Rate||23.55%|
|Net Current Asset Value (NCAV)||$0.47|
Balance Sheet – 11/30/2013
Earnings Per Share
Earnings Per Share – ModernGraham
Red Hat Inc. does not qualify for either the Defensive Investor or the Enterprising Investor. Â The Defensive Investor is concerned with the lack of dividend payments, the low current ratio, and the high PEmg and PB ratios. Â The Enterprising Investor has an issue with the low current ratio and lack of dividend payments. Â As a result,Â value investors following the ModernGraham approach based on Benjamin Graham’s methods should research other opportunities through a review of ModernGraham’s analysis of Microsoft Corp (MSFT) and ModernGraham’s analysis of Oracle Corp (ORCL). Â As for a valuation, the company appears to be overvalued presently, having grown its EPSmg (normalized earnings) from $0.38 in 2010 to only $0.92 for 2014. Â This level of demonstrated growth does not support the market’s implied estimate of 23.55% earnings growth and leads the ModernGraham valuation model to return an estimate of intrinsic value that falls below the price.
The next part of the analysis is up to individual investors, and requires discussion of the company’s prospects. Â What do you think? Â What value would you put on Red Hat Inc. (RHT)? Â Where do you see the company going in the future? Â Is there a company you like better? Â Leave aÂ comment on ourÂ Facebook pageÂ or mentionÂ @ModernGrahamÂ on Twitter to discuss.
If you like our valuations, why not check outÂ ModernGraham Stocks & Screens? Â It’s a great way to review the valuations while screening for things like low PE ratio, undervalued companies, etc.!
Disclaimer: Â The author did not hold a position in Red Hat Inc. (RHT) or any other company mentioned in the article at the time of publication and had no intention of changing that position within the next 72 hours. Logo taken from wikipedia; this article is not affiliated with the company in any manner.