Red Hat, Inc. – Growth at Any Price

Investors are buying up shares of technology companies quickly as fears of an economic collapse begin to dissipate and margins for many companies are quite attractive. Red Hat, Inc. (RHT:NYSE), the provider of open source operating systems for enterprises has seen its stock rocket 268% from the low set last November. Investors are now willing to pay a hefty premium for the stock due to its stable track record of sales and earnings growth.

Recently, the company announced results for its fiscal second quarter (Red Hat operates with a February fiscal year end). The results came in ahead of expectations with the company posting earnings of $0.20 per share from revenue of $184 million. Sales were up 12% above the same quarter last year, which indicates that businesses are willing to invest in technology even while the purse strings are held tight for many other expenditures.These purchases are often made with the assumption that stronger technology will help companies operate more efficiently as many are looking for ways to maintain business levels while laying off employees. This helps to explain why productivity levels have increased on a macro scale even while unemployment rises to new levels. Red Hat is capitalizing on this trend and offering significant value to customers.

Merrill Lynch (MER:NYSE) had spent the last quarter with Red Hat at a "hold" ranking, but after the quarterly release the brokerage firm raised it's price objective and once again recommended clients buy this well-known technology stock. Last quarter, Merrill had become concerned with a declining level of billings, but with year-over-year billings now increasing to 8% from a low 3% last quarter the picture appears a bit brighter. Merrill cited three primary reasons for it's positive assessment of Red Hat:

1. Forward Metrics Strengthening – A growing backlog of business appears to ensure that the company will be able to maintain revenue growth for quite some time.
2. Upsell Thesis Playing Out – The company is seeing its premium products (with higher margins) move off the shelf with 23 of the top 30 renewals opting for higher margin products
3. Share Gain Potential – There are quite a few high profile competitor renewal contracts that will come up over the next three years.  Merrill estimates $240 million of potential new business from these contracts.

So as far as the business is concerned, it looks like Red Hat is firing on all cylinders and growing profit at a steady clip. This is just what we want to see as growth stock investors – but there is just one problem.