As Apple (AAPL) continues to execute time and time again, the valuation becomes increasingly lucrative (click here for explosive possibility). This tech giant is growing at breathtaking rates, defying the "law of big numbers", and yet trades at just 14.7x forward earnings. I view the long story of Apple as almost a mirror image of what is going on at Red Hat (RHT). For the year to date, both companies have gained around 48% in shareholder value. The only difference is that Red Hat's free cash flow doesn't support the company's valuation compared to what is the case for Apple.
While I recommend Red Hat to speculative investors looking for high-risk adjusted returns, I recommend Apple and Oracle to conservative investors looking for a value discount.
In this article, I will run you through my DCF model on Red Hat and then triangulate the result with a review of the fundamentals compared to Oracle (ORCL) and Apple. I find that Oracle and Apple are more attractive investments than Red Hat right now.
First, let's begin with an assumption about the top-line. Red Hat finished FY2011 with $1.1B in revenue, which represented a 24.6% gain off of the preceding year: acceleration. Analysts model a 18.7% per annum growth rate over the next half decade or so, which appears reasonable given the low base that the firm has to grow off of.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods sold as 15.6% of revenue versus 48.2% for SG&A, 18.5% for R&D, and 4.6% for capex. Taxes are estimated at around 30% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model.)
We then need to subtract out net increases in
