Is Mellanox STILL Presenting Foolish Value?

Brian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

On Oct. 23 I published an article entitled, “Mellanox: One Foolish Question for Those Who Sold on Thursday,” which criticized investors who sold the stock following its sell-off after earnings. Looking back, the sell-off proved to be a great buying opportunity (as I predicted), but is the stock still presenting foolish value?

Mellanox: A Recap

The reaction following Mellanox’s (NASDAQ: MLNX) quarterly report was one that I believed would create obvious value. Honestly, I could not determine the reasoning behind why someone would’ve sold behind such strong earnings. Sure, the company missed revenue guidance by $3 million for its upcoming quarter, but demonstrated explosive growth and is expected to continue its breakout growth clear into next year.

If you take a look at Mellanox’s earnings last quarter compared to the previous year, then you will see one of the great growth stories of this era. It is a company that grew its top line by nearly 130%, and posted net income of $48.40 million, a gain of more than 900% year-over-year. This is a company that has a storied history of blowing away its own guidance. Therefore, the fact that it was short of expectations by $3 million (for its upcoming quarter) is irrelevant, as history tells us that it should post better than expected earnings.

Mellanox: A Value Investment?

In my previous article I “suggested” that Mellanox was a value investment. For value investors such as myself Mellanox may not have the characteristics that value investors typically seek in a stock. However, you must take into consideration its growth, and the valuation that the market places on companies with similar levels of growth.

At $85 Mellanox is trading with a price/sales under 8.0 and a forward P/E ratio of just 20.43. Now, find me another technology company with similar growth (expected 100% bottom line growth next 12 months) with the same metrics. The closest two companies that I could identify are 3D Systems (NYSE: DDD) and Red Hat (NYSE: RHT). Take a look at how the three companies compare:

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p>Price/Sales</p> </td> <td> <p>Trailing P/E Ratio</p> </td> <td> <p>Forward P/E Ratio</p> </td> </tr> <tr> <td> <p>Mellanox</p> </td> <td> <p>7.91</p> </td> <td> <p>37.58</p> </td> <td> <p>20.43</p> </td> </tr> <tr> <td> <p>3D Systems</p> </td> <td> <p>7.75</p> </td> <td> <p>66.32</p> </td> <td> <p>35.53</p> </td> </tr> <tr> <td> <p>Red Hat</p> </td> <td> <p>7.34</p> </td> <td> <p>61.29</p> </td> <td> <p>26.93</p> </td> </tr> </tbody> </table>

As you can see, each of the three companies above is of near equal value in terms of valuation compared to sales. However, valuation compared to bottom line fundamentals and expected growth is significantly different. Mellanox is expected to nearly double its profit over the next 12 months, 3D Systems growth is expected to be slightly less, and Red Hat’s slightly more. However, keep in mind, these three companies are the closest possible match that I could find, meaning the majority of technology companies with this growth sport much larger valuations. Also, Mellanox has a storied history of crushing expectations, making near 100% growth conservative.

Red Hat and 3D Systems trade with forward ratios between 27 and 35.50, which is a massive premium compared to Mellanox. In fact, some might even argue that Red Hat is presenting value as well. If the average forward ratio for a company seeing Mellanox’s growth rate is 30, then Mellanox is still trading at a 50% discount, or a one-year price target between $125 and $130, making it a value investment. 

BrianNichols owns shares of MLNX. The Motley Fool owns shares of 3D Systems and has the following options: short JAN 2014 $55.00 calls on 3D Systems and short JAN 2014 $30.00 puts on 3D Systems. Motley Fool newsletter services recommend 3D Systems. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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