10 Stocks for 2013: #3 - F5 Networks

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

We started our 10 Stock portfolio for 2013 last week with Intuitive Surgical (ISRG) and Apple (AAPL), and continue today with another technology stock and a familiar name to readers of Fastball Financial site, F5 Networks (NASDAQ: FFIV).  We've recommended F5 numerous times at Fastball Financial, mostly with good results when buying on dips.  It was part of our list of 5 Tech Stocks for 2012, but unfortunately gave us some poor results during that time period of 9/24 - 12/21 falling 8.2%, mostly on softer than expected earnings.  However, F5 has bounced back and we think that it is poised for a good year in 2013.

F5 provides solutions that optimize and secure networks.  In their words: "With F5 solutions in place, businesses gain strategic points of control wherever information is exchanged, from client devices and the network to application servers, data storage, and everything in between."  F5 is in a highly competitive segment, where the eventual market share leader can enjoy great profits and a sustainable advantage for many years as the industry standard.  While F5 seems to be the front-runner right now, there are plenty of companies coming after it hard.  In fact, Cisco and Citrix, two of the bigger names in the industry, are teaming up in a fight against F5 in particular (see F5's reaction here).  This will be a tough challenge, but the rewards are tremendous if F5's technology wins.

Valuation

F5 certainly isn’t cheap at a Price-to-Earnings-to-Growth (PEG) ratio of 1.2.  That’s not overly expensive, but not quite as cheap as it was in 2011. However, it is still a fair enough value to jump in  and catch the opportunity from the sell-offs during 2012. 

Cash Flow

As you can see from the chart above, F5 has rapidly grown its cash flow from operations over the past several years.  This is a clear sign of a healthy company that is ready to continue growing further, assuming that their products continue to beat their competitors.

Return on Equity

An important metric to follow is Return on Equity (ROE).  ROE calculates the profit that the company earned, compared to its Shareholder’s Equity.  This metric is important to monitor because some companies can show good earnings growth, but if all they are doing is sitting on that earnings growth, the returns on their accumulated equity will start to decrease.  F5’s ROE has soared higher to a healthy 22.5%, yet another sign F5 is doing well creating additional shareholder value.

Alternates: SalesForce.com, Rackspace and Red Hat

If you're looking for other options as far as fast growing technology companies, there are plenty of them.  My favorites are SalesForce.com (NYSE: CRM), Rackspace (NYSE: RAX) and Red Hat (NYSE: RHT).  SalesForce and Rackspace were also part of our aforementioned 5 Tech Stocks for Fall 2012, both producing 10%+ gains over that 3-month period.  Red Hat was a contributor in our 5 Tech Stocks for Fall 2011, producing a 14% gain over that 3-month period

SalesForce.com

SalesForce.com provides customer relationship management (CRM) software through the “cloud.”  They have also incorporated a focus on social connectivity within the CRM.  SalesForce.com is a battleground stock with lots of hype and even more haters.  But even the haters cannot deny that SalesForce.com has provided its investors with tremendous returns over the past few years.  Investors often look at the company's earnings and wonder how the heck this stock price keeps climbing.  The answer is simple: they continue to grow cash flows from operations.  On the income statement, much of their revenue gets deferred over the life of the contract, while they still incur marketing and overhead costs immediately.  All of that (plus their extremely high spending on Marketing), makes for an ugly income statement.  But their cash flow and rapidly growing market share are beautiful.

Rackspace

Rackspace provides cloud computing services for all sizes of corporations.  It is at the heart of the “cloud” expansion.  As a result, it stands to benefit tremendously from the drastic and rapid shift to cloud computing.  Rackspace chose to utilize an open source solution instead of developing a proprietary model.  There are upsides and downsides to both.  A proprietary model, if successful, can provide a huge dominance in a market.  However, open source provides an easier method to penetrate a market, while leaving the door open a bit for other companies to steal market share or dominate the market entirely.

What many successful companies have done though is create proprietary control over an open architecture.  If Rackspace can have its OpenStack become the de facto standard, while leaving it open for others to develop and improve the code, then other vendors and customers will have a vested interest in making sure that OpenStack, and therefore Rackspace, is successful.  For example, Red Hat has recently focused a lot of efforts into supporting and providing services for OpenStack.  Support from external vendors like this is critical for Rackspace’s long-term growth and market dominance.  Rackspace is not a cheap stock by any means, so it is prudent to wait for a pull back to buy this one.  As the chart above shows, those pullbacks have historically been great opportunities.

Red Hat

Red Hat produces open source enterprise software solutions, most notably Linix and JBoss middleware.  Similar to Rackspace, they don't have a proprietary product, but what they do have is best in class solutions for open source products.  As open source seems to be gaining more steam, Red Hat stands in perfect position to benefit from this trend.  It has produced stellar results over the past several years; I expect more of the same in 2013.  It has a hefty P/E ratio of 73, so similar to Rackspace, you should wait for pullbacks to buy this stock.

Bottom Line

As I mentioned in the Apple post from last week, there are plenty of growth opportunities for technology stock in the coming years.  2013 should be another strong year for the technology leaders.  F5 has a solid history of such growth and leadership in its industry.  It had a rocky 2012, but its historically low valuation is providing an opportunity heading into 2013.  If you don't believe in F5, then perhaps SalesForce.com, Rackspace or Red Hat could provide you with a similar opportunity in an industry that interests you.  However, you should wait for a pull back to buy any of these companies.  History has shown that you will likely get one and it will be a great buying opportunity.

Thanks for reading!  More to come on our list of 10 Stock Portfolio for 2013 over the next two weeks. 


Zaegs owns shares of F5 Networks. The Motley Fool recommends F5 Networks, Rackspace Hosting, and Salesforce.com. The Motley Fool owns shares of F5 Networks. 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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