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Why Arista Networks Has More Upside Ahead in 2019

Though 2018 ended on a sour note, shares of cloud-computing hardware provider Arista Networks (NYSE: ANET) have been rallying on strong results. It has become a leader in data center and related technology -- including 100G and the new 400G speed standards -- and the hardware company continues to post growth rates well into the double digits. With momentum at its back and the internet only growing in importance in the global economy, it's not too late to jump aboard the Arista Networks train.

2018 in review

Arista shares ended up declining 11% in 2018, but it was hardly a bad year. Profitability was held in check due to a diverse set of problems -- most notably U.S.-China trade war tariffs and a $400 million settlement with rival equipment maker Cisco. Nevertheless, sales continued to soar as Arista's open source products for cloud computing gained traction across all aspects of the business.

Metric

Full-Year 2018

Full-Year 2017

YOY Change

Revenue

$2.15 billion

$1.65 billion

31%

Gross profit margin

63.8%

64.5%

(0.7 p.p.)

Operating expenses (excluding legal settlement)

$1.10 billion

$591 million

18%

Earnings per share

$4.06

$5.35

(24%)

Adjusted earnings per share

$7.96

$5.61

42%

YOY = year over year. P.p. = percentage point. Data source: Arista Networks.

Masking some pain was a record year of sales to Microsoft as the software giant continues to evolve into a cloud-based services provider. Multiple new project awards and the realization of deferred revenue added up to Microsoft accounting for 27% of total sales. Though that figure from Microsoft should ease back toward 10% in 2019, other "cloud titans" that Arista sells to, such as Amazon, Alphabet's Google, and Facebook, will pick up the slack and provide substantial growth once again in the new year.

Then there's new technology, and not just 400G equipment for data centers. A myriad of new use cases for Arista's products that help support internet connectivity is being put to use, and management thinks all of its operating segments will grow by double digits in the year ahead. The midpoint of first-quarter 2019 revenue guidance calls for a 25% year-over-year increase. However, Arista is no cheap stock. Is it still worth considering?

Image source: Getty Images.

Expensive, but for good reason

Arista's trailing price-to-earnings (PE) ratio is at 54.0 as of this writing. That's half a century's worth of profits an investor would be paying for to buy the stock right now. Adjusting for one-time items and share-based compensation, the PE ratio falls to 33.2, and price to free cash flow (money left over after basic operations and capital expenditures on property and equipment) is 34.9. Those are more reasonable valuations, but still a steep price to pay.

It may still be a worthwhile purchase, though. Twelve-month forward PE based on profit estimates is a mere 19.5, implying a huge move higher for the bottom line. A few things make that possible. First, there's the $400 million settlement with Cisco that will drop out of the equation during the summer. Plus, if Arista keeps growing revenue by double digits, that will equate to an even higher move in earnings.

Thus, this tech equipment maker could be well worth the premium pricing. With growth showing no signs of faltering, the stock is worth a look.

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John Mackey, CEO of Whole Foods Market, an AMZN subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Teresa Kersten, an employee of LinkedIn, a MSFT subsidiary, is a member of The Motley Fool's board of directors. Randi Zuckerberg, a former Director of Market Development and Spokeswoman for FB and sister to CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. Nicholas Rossolillo and his clients own shares of Alphabet (C shares), Arista Networks, FB, and MSFT. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), AMZN, Arista Networks, and FB. The Motley Fool owns shares of MSFT. The Motley Fool has a disclosure policy.

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