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SolarWinds Inc.

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SolarWinds Inc. (SWI) has an impressive record of outperforming quarterly earnings expectations; a trend that continued in its third quarter with a positive surprise of 14.3%. Shares of this specialized software maker for IT professionals are up 82.0% year-to-date.

What’s even more encouraging for this Zacks #1 Rank (Strong Buy) is the expected earnings growth rate of 20.0% over the next 5 years, which is higher than the industry growth rate of 18.0%.

Solid Third Quarter Beat

On October 25, Solarwinds reported third quarter earnings per share of 32 cents, topping the Zacks Consensus Estimate of 28 cents.

Revenues grew 33.0% year over year to $71.7 million, driven by higher license and maintenance revenue. A solid performance for the commercial business drove License revenue, while Maintenance revenue growth could primarily be attributed to strong customer retention. Geographical contributions were strong too, particularly in the European region.

Margins expanded on the higher revenue base and cost control initiatives.

Upbeat Guidance

Considering its product demand, SolarWinds expects revenues to grow between 25% and 27% year over year in the fourth quarter. Management expects non-GAAP diluted earnings per share of 31 cents to 33 cents.

For fiscal 2012, management expects revenues to grow between 33.0% and 34.0%. Non-GAAP diluted earnings per share are forecasted at $1.31 to $1.32.

Earnings Estimates Moving Higher

Over the last 7 days, the Zacks Consensus Estimate for 2012 has gained approximately 4.4% to $1.18 per share. This represents an increase of 28.42% from 92 cents in fiscal 2011. Meanwhile, the Zacks Consensus Estimate for 2013 is up 2.3% to $1.36 in the same time, suggesting a year-over-year increase of 15.48%.

Premium Valuation Makes Sense

Considering the company’s growth prospects, a premium valuation appears justified. The stock has a PEG ratio of 2.1, compared with the peer group’s 0.7. SolarWinds is also trading at a P/S and P/B of 15.34x and 10.96x, respectively, representing a premium of 569.9% and 326.5% from the peer group averages. Growth seems imminent with a return on equity (ROE) of 27.2%, which is well above the industry average of 13.5%.

Chart Shows Growth Potential

The 12-month EPS chart clearly shows that both share prices and earnings have trended higher over the last few years. The current momentum appears to be driven by a growing client base and price increases, which are reflected in estimate growth trends.

Currently, the share price is hovering around $52.00. The consensus estimates for 2012 and 2013 are trending upward. The estimate revision graph indicates a steep upward trend through fiscal 2015. As illustrated in the chart below, share prices should increase at a similar or higher rate than the estimate revision trend.

Founded in 1999, Texas-based SolarWinds provides information technology (IT) infrastructure management software targeting IT professionals. The company’s offerings help in solving day-to-day problems faced by the IT professionals in managing networks, applications, storage, and physical and virtual servers. The software can easily be downloaded from the company’s websites and implemented promptly into the IT systems. SolarWinds’ customers include small- and mid-size businesses, large enterprises, and the local, state and federal governments.

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