Red Hat Missed Guidance Isn't That Bad

NEW YORK (TheStreet) -- If you're a current Red Hat (RHT) investor Wednesday's earnings release must have felt like getting caught in the rain without an umbrella while wearing your favorite Borsalino.

Red Hat's stock gained about 10% from a year ago and remains in a bullish trend. Red Hat's CEO James Whitehurst announced passing of the billion-dollar mark in annual revenue.

While part of the weakness looking forward is blamed on the strong dollar and economy, investors need to know that this is what happens when you invest in a company with a price-to-earnings ratio that takes over half a century in earnings to pay for a share (PE of 50). At least most of the market cap losses appear to be baked in the cake at this point.

Stocks with a price-to-earnings ratio over 20 have historically underperformed the market. Does this mean you should not invest in growth companies sporting multiples above 20? No; however, it does mean when you consider an investment such as Red Hat, you better be ready for a bumpy ride. Wednesday's fall was more turbulence than a shifting sentiment in the company or management.

Oracle's (ORCL) recent earnings release was met with tempered enthusiasm and price appreciation. Everyone (except of course Red Hat) loves Microsoft (MSFT) again after displaying the new Surface laptop/tablet/gizmo. Even with trumpets blaring for the Surface, the Internet is where everything is happening, and where there is Internet, there is Linux.

Where there is Linux, there is Red Hat making sure pages are served quickly and correctly. (Read my article Microsoft's Impressive Product Still Needs Perfect Execution.)

Based on my experience with gap downs following guidance similar to Red Hat, investors will likely see the short-term low Thursday or Friday. With Wednesday's closing price of $56.50 and after hours trading closing near $51, more downside pressure probably won't last long.

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