Don’t Touch Red Hat Inc (RHT) Stock After Its Q1 Bonanza

Red Hat is red-hot, and that's the problem. Q1 earnings were great, but RHT stock has become incredibly stretched.

Open-source software specialist Red Hat Inc (NYSE:RHT) is roaring at Wednesday’s open. The catalyst? A Street-beating first-quarter earnings report that has RHT stock up by about 9%, extending shares’ gains to nearly 40% about midway through 2017.

Don't Touch Red Hat Inc (RHT) Stock After Its Q1 Bonanza
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Before the cloud, software was a seasonal business.

People bought packaged software near the end of the year, so it could be written off, and this was reflected in the results of the players. Revenues peaked in the fourth quarter, and profits dropped in the third as advertising buys were made.

That was then. In the cloud era software, like hardware, is something you rent. Seasonality is gone, and customers are more tightly locked-in to their suppliers than ever before.

No one has benefited more from this change than RHT stock holders, and that’s increasingly true on Wednesday. Red Hat reported what analysts decided were monster earnings on June 20, for the quarter ending in May, and that has shares at levels last seen during the 1999-2000 bubble.

Red Hat’s Rising Slope

Red Hat stock had already been riding high, up 29% just since the start of the year. The latest results:

  • Net income of $73.19 million (40 cents per share)
  • Adjusted earnings of 56 cents per share (53 cents estimated)
  • Revenues of $676.8 million ($648 million estimated)
  • Increased full-year earnings guidance of $2.66-$2.70 per share (from $2.60-$2.64)
  • Increased full-year revenue guidance of $2.785 billion-$2.825 billion (from $2.72 billion-$2.76 billion).

This quarter’s results were great, but it was that promise of more to come that made RHT stock holders swoon.

Red Hat takes its name from its enterprise version of Linux, an open-source operating system based on Unix. It has long been an open-source leader, giving away a version called Fedora and charging only for support.

The company’s shift to cloud under CEO Jim Whitehurst has made RHT a major player in cloud application development, regularly compared with Microsoft Corporation (NASDAQ:MSFT) and Alphabet Inc (NASDAQ:GOOGL). It also has made Red Hat’s earnings predictable, drawing 10% or more of revenue to the net income line, growing at a steady 20% per year.

Red Hat’s specialty is private cloud, corporate data centers transformed with cloud software into mega-systems compatible with public infrastructure players such as Google and Microsoft. Within this area the company is becoming increasingly dominant, as it protects companies from being locked-in to a single infrastructure vendor.

The latest numbers put Red Hat shares at dot-com levels, when open source was a new concept and profits just a twinkle in the corporate eye.

Bottom Line for RHT Stock

Other enterprise players have had to adapt to the new cloud era, and their transformations are only now starting to yield results. Cisco Systems, Inc. (NASDAQ:CSCO), which also reported earnings June 20, is now focused on selling security as a service, but its quarterly revenue streams are now showing the same stability as Red Hat, albeit without Red Hat’s growth.

Adobe Systems Incorporated (NASDAQ:ADBE) turned its own graphics software into the “creative cloud,” also sold by subscription, and its numbers are showing a steady march upward as a result. By locking in customers a monthly enterprise subscriptions, Adobe has also been increasing its profitability, and the stock is up almost 40% just in 2017.

As investors have recognized the value in cloud software leadership, it should be noted, valuations have become stretched. RHT stock was trading at a price-to-earnings multiple of nearly 62 even before the latest news came out, and ADBE trades at nearly 50 times earnings.

The hope of investors is that cloud earnings are sustainable, resistant to a downturn, and that may be true to an extent. But such high multiples are seldom sustained through a recession, as attention turns to value. And if you’re not in on the new cloud game, you have probably missed this cycle.

The good news is that there will be another one, and Red Hat should be around for it.

Dana Blankenhorn is a financial and technology journalist. He is the author of the historical mystery romance The Reluctant Detective Travels in Time, available now at the Amazon Kindle store. Write him at or follow him on Twitter at @danablankenhorn. As of this writing he owned no shares in companies mentioned in this article.

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