Why Red Hat Looks Like a Good Investment Despite an Expensive Valuation

Red Hat (RHT, Financial) shares have gained in the last year and given the growth of the open hybrid Cloud, there is a possibility that the stock's ascendancy will continue in the future. But is Red Hat worth 74 times last year's earnings at which it currently trades? Let's find out.

Expensive, but enticing

It is evident from Red Hat's trailing P/E ratio that it is expensive. In fact, other companies such as Microsoft (MSFT, Financial) and Oracle (ORCL, Financial) that operate in the Cloud computing environment are way cheaper. But, then, Red Hat is a specialist platform-as-a-service provider, and it is better positioned when compared to its rivals to benefit from the growth of the open hybrid Cloud.

As such, Red Hat has enough resources at its disposal to invest in product development to benefit from the cloud opportunity. Also, apart from Red Hat's fundamentals, if we look at the opportunity present in the end market, it will become clear that the stock is a good investment despite an expensive valuation.

Given the benefits of the hybrid Cloud, it is not surprising to see that Red Hat's solutions are gaining acceptance in the end market. For instance, last quarter, the company had renewed all of its 25 key deals, which indicates that its customer retention is strong. More importantly, the deals were renewed at 120% of the value of the earlier contract.

Apart from contract renewals, Red Hat is also landing new contracts. It signed 30 new deals last quarter that were worth $1 million or more, apart from closing 12 deals that were valued at more than $5 million.

Also, Red Hat is successfully cross-selling its product range to customers. The company sells several Cloud products that range from storage, OpenShift CloudForms, OpenStack and Middleware, its customers have the choice of buying all their needs under one roof.

New server products will aid growth

Now, to tap the Cloud opportunity, it is important for Red Hat to continue developing new solutions as there is stiff competition in the market. As a result, the company has launched its Red Hat Storage Server 3.0, which will allow customers to scale-out file storage. This new server is capable of serving a number of applications, ranging from "data intensive enterprise workloads including big data, operational analytics, enterprise file sharing and collaboration."

Additionally, Red Hat Storage Server 3 will allow the company to benefit from software-defined networking, which is growing rapidly.

Hence, this is another fast-growing area that will help Red Hat sustain its impressive growth and justify its expensive valuation.

Conclusion

Red Hat is on track to profit from the hybrid Cloud market and software-defined networking. It is renewing existing deals at lucrative prices and is also landing new customers. Also, the company is on track to deliver strong earnings growth in the next five years, and investors can expect the stock to trade at more reasonable levels going forward. As such, despite being expensive, Red Hat looks like a good long-term investment.