Have investors already priced in Red Hat Inc’s (RHT) growth?

Growth expectations for Red Hat Inc (NYSE:RHT) are high, but many investors are starting to ask whether its last close at $77.11 can still be rationalized by the future potential. I’m going to take a look into that. Check out our latest analysis for Red Hat

What are the future expectations?

Analysts covering RHT are predicting a 24.7% increase in earnings over the next 1-2 years. That means that we can be expecting the earnings grow to $2.25 levels.

NYSE-RHT-past-future-earnings-Mon-Oct-31-2016

In the same period we will see the revenue grow from $2,234 Million to $3,149 Million in 2019 and profit is predicted to shoot from $220 M to $556 M in 2019, roughly growing 2.5x. Margins are predicted to be a respectable 17.7% during this time as well.

What is Red Hat’s value based on its current earnings?

Red Hat is trading at price to earnings (PE) ratio of 63.7x, this also tells us the stock is overvalued based on current earnings compared to the Software industry average of 36x and overvalued when compared to the US market average of 25.5x .

NYSE-RHT-PE-PEG-gauge-Mon-Oct-31-2016

P/E ratio is simply a stock’s price divided by its earnings per share (EPS). It is a straightforward and popular way of assessing how much investors are willing to pay for each dollar a company earns.

Is RHT’s share price justified by its earnings growth?

We already know that RHT appears to be overvalued when compared to its industry average.But to properly examine a value of a high growth stock like Red Hat we must include its earnings growth in the calculation using the PEG ratio.

The PEG ratio (price/earnings to growth ratio) is a valuation metric used to assess the relative trade-off between the price of a stock, the earnings per share (EPS), and the company’s expected growth. Since P/E ratio is in general higher for a company with a higher growth rate, using just the P/E ratio would make high-growth companies appear overvalued relative to others. By dividing the P/E ratio by the earnings growth rate, the resulting ratio is considered to provide a more complete picture when comparing companies with different growth rates.

PE ratio of 63.7x and predicted 24.7% growth in earnings next year give Red Hat a quite high PEG ratio of 2.6x. This tells us that when including its growth in our analysis Red Hat’s stock can be considered overvalued based on the fundamenals.

What next? See our FREE analysis report on Red Hat or find stocks which are undervalued based on their future growth potential.