The S&P 500 is the most highly regarded stock market index in the U.S., composed of the 500 largest companies in the country. Given the breadth of its constituent companies, it's considered by many investors to be the most reliable measure of overall stock market performance. To become a member of the S&P 500, a company must meet the following criteria:
- Be based in the U.S.
- Have a market cap of at least $18 billion
- Be highly liquid
- A minimum of 50% of its outstanding shares must be available for trading
- Must be profitable on a generally accepted accounting principles (GAAP) basis in its most recent quarter
- In aggregate, must be profitable over the preceding four quarters.
Arista Networks (ANET -1.59%) has been a member of the S&P 500 since August 2018, but the networking specialist recently completed a 4-for-1 forward stock split. This step is normally the result of years of robust operating and financial results, and Arista Networks certainly meets those criteria. Since its IPO in mid-2014, the stock has soared 3,823% (as of this writing), as the company has been a key player in the evolving data-driven networking industry. Its results aren't just part of some dusty past either. Over the past five years, Arista Networks stock has surged 779%.
Despite its impressive gains, many on Wall Street believe there's plenty of upside ahead. Let's review Arista's path to success and what the future holds.
Image source: Getty Images.
From humble beginnings
Arista Networks was founded in 2008 after creating a groundbreaking network switch to connect servers and other high-speed devices to a network. What made its product fundamentally different was that it offered high-speed data transfer with low latency -- or very little lag. From those humble beginnings, Arista has expanded its offerings to include a wide variety of switches, routers, and other networking hardware that facilitates the flow of data across data centers, servers, and networks.
Keeping data flowing through the ether is big business these days, and the advent of artificial intelligence (AI) has forever altered the playing field. Arista pivoted quickly to pioneer scaled-out Ethernet offerings, which speed up networking for large-scale AI models. Earlier this year, the company debuted Arista Etherlink AI platforms, "designed to deliver optimal network performance for the most demanding AI workloads."
One of it most robust offerings -- the Distributed Etherlink 7700 AI networking platform -- was designed to connect up to 10,000 graphics processing unit (GPU) clusters, the chips that form the backbone of AI processing.
Don't take my word for it. Arista Networks was identified as a Visionary in Gartner's vaunted Magic Quadrant. The company was cited for providing network management tools that simplify operations, offering a differentiated network security strategy, and providing advanced AI and machine learning capabilities. Arista was also selected as a Customer's Choice in Gartner's Peer Insights, which aggregates reviews from existing customers.
As data centers scramble to upgrade their equipment to meet the rigorous demands of AI, many are turning to Arista Networks. That demand is showing in the company's financial results. For the third quarter, Arista generated revenue of $1.8 billion, up 20% year over year and 7% sequentially. This resulted in earnings per share (EPS) that jumped 35% to $2.33. The results were well ahead of management's guidance and Wall Street's expectations.
In light of the robust results, management increased its forecast. For the fourth quarter, Arista is guiding for year-over-year revenue growth of 23% to $1.9 billion.
Analysts are still bullish on Arista Networks
Wall Street has long been known for its wide-ranging opinions, so it's noteworthy that the majority of analysts who cover Arista Networks believe the stock has further to run. Of the 26 analysts who offered an opinion (thus far) in December, 77% maintain a buy or strong buy rating on the stock, and only one recommends selling. Furthermore, Wall Street has an average price target of roughly $108 (post-split), which represents potential upside of 4% compared to Tuesday's closing price.
However, Barclays analyst Tim Long is more bullish than his Wall Street colleagues, maintaining an outperform (buy) rating and recently increasing his price target to a Street-high (split-adjusted) $124. That suggests potential gains for investors of 19% compared to Tuesday's closing price. The analyst noted Arista's recent robust results, increased guidance, and the speed at which it has ramped up its AI offerings. The analyst also cited the company's market share gains in the campus and routing markets.
One fly in the ointment is the stock's lofty valuation. Arista Networks is currently selling for 51 times earnings, which certainly seems expensive. Even its price/earnings-to-growth (PEG) ratio, which accounts for its accelerating growth, comes in at 1.35 when any number less than 1 suggests an undervalued stock. So, there's no denying it trades at a premium.
However, it's important to put that in context. Arista Networks has outperformed the broader market by a wide margin over the past five years, generating gains of 779%, 8 times the return of the S&P 500.
When viewed from that perspective, I'd argue Arista Networks is a buy.
