Is Red Hat Inc (RHT) Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Red Hat Inc (NYSE:RHT) fit the bill? Let’s take a look at what its recent results tell us about its potential for future gains.

What we’re looking for
The graphs you’re about to see tell Red Hat’s story, and we’ll be grading the quality of that story in several ways:

• Growth: Are profits, margins, and free cash flow all increasing?
• Valuation: Is share price growing in line with earnings per share?
• Opportunities: Is return on equity increasing while debt to equity declines?
• Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let’s take a look at Red Hat’s key statistics:

RHT Total Return Price data by YCharts.

Criteria	3-Year* Change	Grade
Revenue growth > 30%	68.2%	Pass
Improving profit margin	(6.2%)	Fail
Free cash flow growth > Net income growth	59.6% vs. 75%	Fail
Improving EPS	68.1%	Pass
Stock growth (+ 15%) < EPS growth	64% vs. 68.1%	Pass

Source: YCharts. *Period begins at end of Q2 2010.

RHT Return on Equity data by YCharts.

Criteria	3-Year* Change	Grade
Improving return on equity	24%	Pass
Declining debt to equity	No debt	Pass

Source: YCharts. *Period begins at end of Q2 2010.

How we got here and where we’re going
Red Hat Inc (NYSE:RHT) looked promising, but it was tripped up on both profit margin and free cash flow growth, earning five out of seven passing grades in the end. Despite promising revenue gains, profit margins have declined somewhat. Net income growth has also outpaced free cash flow during our tracked period — however, the raw numbers show that Red Hat’s trailing-12-month free cash flow is actually almost twice as large as its net income. But does that mean Red Hat Inc (NYSE:RHT) will do even better in the future? Let’s dig a little deeper to find out.

In the last month’s quarterly report, Red Hat Inc (NYSE:RHT) reported a 15% increase in revenues while SaaS subscriptions grew by 16%. Total sales were $363 million, of which 87% came from subscriptions. Red Hat Inc (NYSE:RHT) has increased its R&D spending substantially by investing in the “open hybrid cloud,” which is the company’s term for open-source cloud computing that covers a range of functionality and accessibility while allowing a great deal of development freedom. Red Hat Inc (NYSE:RHT) has also launched a scalable Big Data management platform, which all but completes tech-buzzword bingo. All we need now is a mobile-social image sharing something or other.