Buy, Sell, or Hold: VirnetX

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When it comes to investing, knowing when to buy, sell, or hold a stock can mean the difference between making money and losing it in the market. However, making the best decision at the right time isn't always easy. Fortunately, investors can minimize risk by weighing both the pros and cons of a given stock before deciding how to act. Today, let's take a closer look at VirnetX Holding (AMEX: VHC) and evaluate whether investors should buy, sell, or hold this Internet software company.

Because defense contractor SAIC (NYS: SAI) had a hand in creating VirnetX, the software company contains patent technology that could prove valuable down the road. These patents include technology for 4G LTE mobile security. According to the Global mobile Suppliers Association, more than 280 wireless carriers are set to launch LTE networks before the end of this year. With 4G and LTE on track for tremendous growth, there should be no shortage of opportunities for VirnetX as we head into 2013.

The company has also done well in patent court. In 2010, VirnetX won a patent suit against Microsoft (NAS: MSFT) , in which the software giant agreed to pay the company $200 million in settlement fees. Microsoft was also forced to license virtual private network technology from VirnetX. The triumph gave VirnetX bulls hope that the company could win other big lawsuits against similar tech companies in the space.

In May, VirnetX secured a one-time payment from Aastra Technologies for use of its IP-encrypted products. As my fellow Fool Rick Munarriz pointed out, the deal also entitles VirnetX to ongoing royalty payments, which bodes well for investors. Additionally, it's encouraging that VirnetX CEO Kendell Larson still holds more than an 18% stake in the company.

Unfortunately, VirnetX didn't have the same luck when it went up against Apple (NAS: AAPL) in a recent patent law battle. VirnetX's claim that Apple's iDevices infringed on its intellectual property rights hit a wall last month when the International Trade Commission upheld a judge's previous decision to dismiss the case. Thus, it looks like the company won't be getting those royalties from Apple after all -- at least not this time around.

More importantly, it is worrisome that VirnetX relies so heavily on lawsuits to make money. While the company certainly has a valuable patent portfolio, I'm not sure that patent-litigation alone can provide the aggressive growth that VirnetX needs to live up to its current valuation. The U.S. court system can be highly unpredictable. In fact, according to TheWall Street Journal, "[I]n recent years federal legislation and court rulings have made it harder for plaintiffs to win patent cases." It also doesn't help that the companies VirnetX is taking to court have deep pockets and tons of resources to fight back.

While there is a lot of uncertainty surrounding this stock, VirnetX does maintain a favorable position in the 4G LTE market. If you don't mind the inherent risk in this company, you may consider holding on to the stock in hopes of a big payout down the road. That said, there's no guarantee that future lawsuits will be decided in its favor.

Investors that choose to sit tight can expect a bumpy ride, as the company's fate is largely tied to how its lawyers perform in court. Shares of VirnetX currently trade around $28 apiece. However, the stock carries a dangerously high forward P/E of 560. This valuation seems pretty pricey for a company that's still in the red. It's worth mentioning that the stock has a one-star rating on Motley Fool CAPS, with 129 members giving it a rating of outperform and 85 members betting it will underperform the market.

Final answer
Whichever side of the line you stand on, there's no denying the tremendous risk involved. Still, VirnetX's trove of patents may deem it worthwhile -- if you can stomach the volatility. The company currently holds 20 U.S. patents and 26 international ones, not to mention more than 100 patent applications that are still pending.

These patents may prove valuable down the road, but for now I think the volatility far outweighs the value. In fact, there are plenty of other tech companies with strong patent portfolios that are far less risky. Take Microsoft, for example. VirnetX may have won its lawsuit against the software giant, but it doesn't hold a flame to the reliable profits provided by Microsoft's core business. Get informed of key facts and market data on Microsoft in the Fool's latest premium research report. In addition to valuable analysis, you'll also get a full year of up-to-the-minute updates on the stock. To take advantage of this limited-time offer, click here now.

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Fool contributor Tamara Rutter owns shares of Apple. Follow her on Twitter, @TamaraRutter, for more Foolish insights and investing advice. The Motley Fool owns shares of Microsoft and Apple. Motley Fool newsletter services have recommended buying shares of Apple and Microsoft. Motley Fool newsletter services have also recommended creating a bull call spread position in Apple and a synthetic covered call position in Microsoft. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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