This Stock Has it All But is Quite Expensive

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

Shareholders of SolarWinds (NYSE: SWI) must feel quite happy. The stock has experienced a decent increase in price over the past twelve months, rising from $39 to more than $59, which represents a gain of more than 50%. Jim Simons of hedge fund Renaissance Technologies expressed his bullish attitude toward this stock, buying nearly 1.5 million shares in the third quarter of 2012. Should investors consider SolarWinds a good investment opportunity now? Let’s find out.

Business snapshot

SolarWinds, which was incorporated in 1999, designs and develops infrastructure management software for IT professionals in many organizations. It has three main product categories: core products, transactional products and free tools. The company, which licenses its software directly to customers, derives its revenue from two sources: license sales and maintenance services.

Most of its sales come from customers who have used its core products during a trial period, the company indicated. More than half of its 2012 total revenue, or $145 million, was generated from maintenance services, while license sales contributed $124 million to the top-line results.

SolarWinds seems to have a diverse customer base, with only one distributor accounting for 10.2% of total sales in 2012.

A fast growing business with a debt-free balance sheet

SolarWinds could be considered a fast-growing business. For the past five years, it has experienced top-line and bottom-line growth at rapid rates. Revenue increased from $93 million in 2008 to $269 million in 2012, while net income rose from $22 million, or $0.37 in EPS, to $81 million, or $1.07 in EPS, during the same period.

Interestingly, the company is also a cash-generating machine with its growing cash flow. Its operating cash flow soared from $35 million to $143 million, whereas free cash flow followed the same rising trend, climbing up from $31 million to $138 million since 2008.

What makes me interested in the stock is the fact that SolarWinds has managed to grow rapidly without any help of leverage. As of December 2012, it had $383 million in total stockholders’ equity, $229 million in cash and short-term investments, and no debt. The biggest item in its liabilities was deferred revenue at $98 million.

The most profitable but the most expensive

At $59 per share, SolarWinds is worth around $4.4 billion in market capitalization. The market seems to value the company quite expensively at as much as 31.7 times EV/EBITDA. Compared to its bigger peers including CA, Inc. (NASDAQ: CA) and Hewlett-Packard (NYSE: HPQ), SolarWinds is the smallest player but has the most expensive valuation.

CA is trading at around $25 per share, with a total market cap of $11.4 billion. It's valued much more cheaply, at around 6.1 times EV/EBITDA. Hewlett-Packard is the biggest company among the three, with around $46.5 billion in total market cap. At around $24 per share, Hewlett-Packard is valued the cheapest, at only 4.3 times EV/EBITDA.

Of the trio, SolarWinds is the most profitable. Its operating margin of 42.4% is the highest of the group and its 25.1% return on equity is similarly the best. CA ranked second, with a 30.4% operating margin and 16.6% return on equity. Hewlett-Packard is the least profitable company among the three with only 7.9% operating margin and negative return on equity.

CA is a favorite among income investors, boasting of the highest dividend yield at 4%, while the Hewlett-Packard pays investors a dividend with a yield of 2.2%. SolarWinds does not pay any dividends to its shareholders.

My Foolish take

Although SolarWinds is the fastest growing and most profitable company among the three, I am not excited with SolarWinds due to its extremely high valuation. I like CA the most with its decent dividend yield and a much lower valuation. Hewlett-Packard could be considered an opportunistic stock for investors who bet on its turnaround. 

Anh HOANG has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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