As analysts forecast Red Hat Inc (NYSE:RHT) to register robust earnings growth of 19.34% in the coming 12 months, it’s important to take a step back and consider this strong vision. Those invested in the stock should contemplate the factors that are driving this growth, because the sustainability of returns to shareholders can be impacted on in different ways. To get some insight, this article will interpret Red Hat’s margin performance to assist in analysing the revenue and cost anatomy behind the earnings expectations for the future and the impact it has on shareholder returns relative to the wider industry.
A closer look at RHT’s profit margin
At a high level, a company’s ability to earn on their sales efforts can play an important role in determining shareholder value. By calculating RHT’s profit margin, we can take a closer look at this ability and use it to understand what is driving earnings growth.
Margin Calculation for RHT
Profit Margin = Net Income ÷ Revenue
∴ Profit Margin = 337.16 Million ÷ 2.78 Billion = 12.14%
There has been a contraction in Red Hat’s margin over the past five years, due to a 15.21% average growth in revenue outstripping average net income growth of 12.92%, indicating that that a smaller percentage of revenue is being converted in to net income despite the top line growth. RHT’s most recent margin of 12.14% appears to follow this trend, indicating that earnings growth has likely been driven through an increase in revenue rather than improved cost management.
Using Red Hat’s margin expectations as a way to understand projections for the future
Forward looking projections suggest margins will reverse its previous trend and start to expand, with an expectation of 13.05% in annual revenue growth and 17.03% earnings growth expected annually. This suggests future earnings growth is driven further by enhanced cost efficiency alongside revenue increases, which is enlarging the incremental amount of net income that is retained from the forecasted revenue growth. Despite this, those interested in the company should remember that margin expansion can hold various implications on the company’s performance depending on how it operates, which makes further research very important. Profit margins are commonly useful when employed as a comparitive measure to judge a business’ profit-making ability against its industry. For RHT, future profit margin is expected to expand along with the margins in the Software industry, and at the same time, RHT’s forecasted ROE of 30.81% exceeds that of the expected 12.98% ROE of the industry (note that this observation is also influenced by relative debt levels). This suggests that analysts expect Red Hat’s return per dollar of equity will exceed the industry due to the earnings attributes identified in our margin analysis. However, margins use items on the income statement that are prone to being manipulated by various accounting measures, which can distort our analysis. Thus, it is essential to run your own analysis on Red Hat’s future earnings whilst maintaining a watchful eye over the sustainability of their cost management methods and the runway for top line growth.
For RHT, there are three relevant aspects you should further research:
1. Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Valuation: What is RHT worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether RHT is currently mispriced by the market.
3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of RHT? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!