VMWare

2/4/12

For a quick recap of my last three stock picks: CLF is up 7% in three weeks, BRCM is up 7.6% in two weeks and POT is down 1% for the week.  If you acted on any of my recommendations, I would stick with all three as CLF closed at its highest level since September and BRCM closed at its highest level since early October.  Additionally, Broadcom and Cliff’s Natural Resources have been up for 5 straight weeks with a lot of momentum.  While I expected Potash to rally with the broader market, I am not worried about it as the chart is still bullish.  

The stock I am recommending this week is a cloud computing play that after being hammered late last year, has really rallied hard in 2012 and has a lot of momentum.  The stock I’m recommending is VMWare (MW).  The company provides cloud-computing software to businesses.  In 2011, VMWare booked record revenues, operating margins and free cash flows.  Revenues increased 32% to $3.8B.  Opearting margins increased 250 basis points and free cash flows totaled more than $1.9B ($4.51/share).  The company recently guided to revenue increases for Q1 being between 20%-23% increase YOY and continue to look for margin expansion as they roll out new products.  To talk about an earnings blowout, VMWare booked Q4 EPS of $0.62/share, while analysts were expecting only $0.43/share, a 44% earnings beat.

VMWare is currently trading at 31x forward earnings with a Price-to-earnings growth ratio (PEG) of only 1.49.  With only $450M in debt, the company has over $4.51B in cash, equating to almost $11/share.  If you back out the cash, VMWare is trading at just 28x forward earnings, with a market cap of almost $41B.  There are currently 7 strong buys, 17 buys, and 14 holds on the stock with only 1 underperform and 1 sell recommendation. 

Looking at the technicals, VMWare is starting to break out, to the upside.  On February 2^nd, the stock broke through its 200-day moving average.  While it was done on low volume, the entire market is trading on low volume so I’m throwing that out the window.  The stock has respected its uptrend line from the December 21^st low, breaking down only once, but gapping up immediately the next day.  VMWare is trading in triangle formation since that December low with the upper range connecting the December 27^th and January 26^th highs.  This type of up-trending triangle formation indicates a breakout is coming, which I see going to the upside.  I see the next major level of resistance coming at par ($100), which is where the downtrend lines comes into play connecting recent highs made on July 20^th and November 14^th.  A move above $100 should beget a move back up to $110, which would almost match the stock’s recent high of $111.43.  The stock has traded higher for the last four weeks indicating great upward momentum.  The stock has an unfilled gap after its most recent earnings beat on January 23^rd and 24^th.   After challenging that gap four times in the last week, it has since broken away.  With VMWare being a key component of the Nasdaq, and the Nasdaq leading this recent bull market, I see continued upside potential for VMWare. 

VMWare is currently trading at $95.58, up 2% on Friday.  That makes for a good entry point into the stock with a stop loss placed at $89.00 (loss of 7%).  My price target for the stock is $110 indicating an upside of 16%, putting the stock up 30% for the year. 

Full disclosure:  I currently do not own VMW and have no plans to buy the stock in the next week since I am currently overweight in technology.