What Does VMware's Stock Price Say About the Company's Future?

Tuesday Apr 22nd 2014 by Paul Rubens

VMware's current stock market data makes it pretty clear there are some lofty expectations for the company's future prospects. What's behind the optimism?

There's an old saying: a fool and his money are soon parted. The reverse is also true: smart people make money. And a good way to see what smart people are doing is by looking at the stock market.

That's because there is wisdom in crowds, and markets are generally good at extracting that wisdom and reflecting it in stock prices. Virtually Speaking So today let's take a look at a stock price, specifically server virtualization specialist VMware's, and see what we can conclude from it.

Firstly, it is very close to its all-time high — but then so is the stock market as a whole. So that's not particularly illuminating or surprising.

But what is surprising is that VMware's stock price has gone up almost 45% in the last year — a pretty significant gain, I'm sure you'll agree. What's more, the stock is currently on a price to earnings (P/E) ratio of 53.9. That compares with 14.9 for Microsoft, and 21.06 for parent company EMC.

What does the P/E ratio tell us? Well, a number of things. It's a ratio that reflects what the market thinks about the future earnings (i.e. profit after tax and so on) growth potential of a company. A high P/E ratio reflects high expected growth. It can also reflect other things such as the likelihood that the company gets acquired at a higher stock price than the stock's current price.

As a very rough rule of thumb a P/E ratio of 8 - 12 is about average for a mature large enterprise that's doing OK, so it's not surprising that Microsoft is on 14.9 in a market that's near its all-time high.

But 53.9? That is very high indeed. That could suggest that the market has got things completely wrong, and the stock is far too highly priced. But markets don't get things completely wrong. At least, not very often.

More likely it indicates that the market is expecting some pretty strong earnings growth for VMware over the next few years. In fact, VMware's stock has recently been upgraded to a "Buy" by brokerage firm Sterne Agee's senior analyst Alex Kurtz, who has raised his target price for the stock to 126, with a three year price target of 168. That of course would put VMware on an even higher P/E ratio — unless its earnings grow strongly too.

What's Behind the Bullish Optimism for VMware?

So by looking at the stock market data, it's pretty clear that there is some strong optimism about VMware's future prospects. Where does this optimism come from?

Here's a clue. "After discussions with channel partners, we have increasing confidence in VMware's strategy to capture incremental dollars in storage, management, networking and cloud," Kurtz wrote in a research report.

He continues, "Through the maturation of key management products along with the rollout of its hybrid cloud product and new storage platforms, we estimate there is an immediate TAM (total addressable market) of $10 billion for the company and its channel partners to pursue."

Now I am not for one moment suggesting that the stock market, or stock analysts, are infallible. Nor am I giving any kind of investment advice whatsoever.

But I am saying that the market appears to have confidence that VMware's strategy for the future will yield strong earnings growth. This strategy involves server virtualization, cloud technologies, and software-defined storage through initiatives such as Virtual SAN), software-defined networking (thanks to the Nicira acquisition), not to mention mobile device management (through the recent AirWatch acquisition.)

Either that or it has a hunch that VMware will be acquired — which isn't very likely given that EMC owns most of VMware, EMC isn't known to be wanting to divest itself of the company, and it is unlikely to pay over the odds to buy back the part that it doesn't already own.

And as I said earlier: markets don't get things completely wrong. At least, not very often. All of which is to say that if the market is indeed right, then that's very good news for VMware, its customers and its shareholders.

Paul Rubens is a technology journalist and contributor to ServerWatch, EnterpriseNetworkingPlanet and EnterpriseMobileToday. He has also covered technology for international newspapers and magazines including The Economist and The Financial Times since 1991.

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