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Stock Analyst Update

Sun Shines Very Brightly, Turns in Great Quarter

The firm appears to be gaining market share against HP and IBM.

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Sun Microsystems (SUNW) turned in a stellar second fiscal quarter on Thursday, reporting a 27% increase in revenues and a 32% increase in earnings per share.

In a way, these two numbers by themselves tell you all you need to know about Sun. The tremendous top-line growth is the result of both strong demand for Sun's high-powered computers and the company's ability to beat out less-nimble competitors like Hewlett-Packard (HWP) and IBM (IBM).

Meanwhile, Sun's ability to increase earnings per share significantly faster than revenues hints at the company's tremendous internal efficiency, as lower overhead costs as a percentage of sales helped drive net margins up from 9.3% to 9.9%. Days sales outstanding, another key indicator of internal efficiency that measures how fast customers are paying for their goods, plunged to only 52 days from 62 days in the prior quarter. Sun's management runs a very tight ship

Although part of Sun's remarkable sales growth can be attributed to a relatively soft second quarter of 1999--making for an easy year-over-year comparison--the successful December quarter was by no means an anomaly. Sales grew by 25% in the previous quarter, and management believes it can sustain this rate for at least the next six months.

As attractive as the Sun story is, however, investors might want to exercise a bit of caution. Wall Street has long since seen the value in such a fast-growing, well-managed company, bidding Sun's shares up 75% in the past three months and driving the stock's valuation to an extremely rich forward price/earnings ratio of just under 100.

Adding to the stock's risk, Sun will be introducing a new version of the chip that powers its computers later this year, which could result in a temporary sales slowdown as customers delay their purchases until the new chip becomes available. Moreover, the incipient release of Microsoft's (MSFT) Windows 2000 could be potent competition for Sun's Solaris operating system. Although the long-term story is very strong for Sun, the stock's nosebleed valuation and a couple of significant near-term risks suggest that investors would be wise to wait on the sidelines right now.

Pat Dorsey does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.