Arista Networks' (NYSE:ANET) 200% rally over the past 12 months came to an abrupt halt on Feb. 15, when the stock plunged almost 20% after the company released its fourth-quarter earnings. That big drop was surprising, since Arista soundly beat analyst expectations and provided solid guidance for the first quarter.

Investors might be wondering if it's wise to buy Arista's post-earnings dip. Let's take a closer look at Arista's growth figures to see if it's a worthy investment.

A businessman holds a cloud icon in his hands.

Image source: Getty Images.

What does Arista Networks do?

Arista sells switches for generic "white box" network hardware. On their own, these devices are cheaper and less powerful than Cisco's (NASDAQ:CSCO) hardware, but they use cloud-based software -- like Arista's EOS platform -- to do the heavy lifting.

White box networks are cheaper to set up, and can be mixed and matched among multiple hardware vendors and tethered to open source cloud operating systems. This makes them more scalable and flexible than Cisco's all-in-one hardware and software bundles.

Cisco recognized the disruptive threat of Arista's hardware and software years ago. That's why it acquired cloud networking service provider Meraki in 2012, and why it repeatedly sued Arista over patent infringement issues to prevent it from importing its products into the US.

Firing on all cylinders

Yet Arista kept growing. Between 2013 and 2016, its annual sales rose more than 200% as its non-GAAP earnings more than tripled.

In 2017, its revenue rose 46% to $1.6 billion, as its non-GAAP gross margin expanded 40 basis points to 64.8%. Its non-GAAP net income jumped 83% to $442.8 million, while its GAAP net income surged 130% to $423.2 million.

Analysts expect Arista's revenue and non-GAAP earnings to rise 27% and 23%, respectively, in 2018. However, some investors were concerned about CFO Ita Brennan's vague comment about potentially "tough comparables" to its 2017 performance during the fourth quarter conference call.

Big customers and robust overseas growth

Arista finished the year with 4,900 customers, with orders from Microsoft (NASDAQ:MSFT) accounting for 16% of its total revenue. Microsoft's use of Arista's products in its data centers complements its decision to use cheaper AMD server chips alongside Intel's Xeons.

Servers in a data center.

Image source: Getty Images.

The reason is simple -- tech giants like Microsoft need cheaper and more scalable solutions, like the ones Arista or AMD provide, instead of pricier "industry standard" products from companies like Cisco and Intel.

That's why the enterprise market became Arista's strongest vertical for the first time in its history during the fourth quarter. Cloud platform providers came in second.

That support boosted Arista's share of the global switching market 150 basis points annually to 5.6% during the third quarter of 2017 according to IDC. Cisco's share fell from 57% to 56.7% during the same period. Arista doesn't compete against Cisco in routers, but it believes that it can eventually replace traditional routers with its FlexRoute software.

Arista is also generating plenty of revenue in overseas markets, which softens the impact of Cisco's legal attacks in the American market. 73% of Arista's revenues came from the Americas in 2017, with the remaining 27% coming from International markets. In 2016, 77% of its revenues came from the Americas, while 23% came from other international markets.

The bulls and bears are split on Cisco

The bears believe that Cisco could marginalize Arista by beefing up Meraki and integrating the platform more aggressively into its other hardware and software products.

Cisco also plans to repatriate $67 billion of its overseas cash, and over $20 billion of that total could be used on R&D or domestic acquisitions aimed at countering Arista. However, many bulls have suggested that it might simply be easier for Cisco to buy Arista, which has an enterprise value of $17 billion.

The bulls will also note that if Cisco had the power to crush Arista, it would have done so years ago instead of trying to throttle its growth with desperate lawsuits.

The verdict: Buy the dip

Arista's 43% sales growth and 77% jump in non-GAAP earnings during the fourth quarter easily beat analyst expectations. Its forecast for 34%-40% sales growth during the first quarter also matched analyst expectations.

Therefore, Arista's sell-off was likely caused by simple profit-taking, over-analyzing Brennan's comments, or mild concerns about its forward P/E of 36, which looks a bit frothy in a volatile market.

It probably wasn't caused by any fundamental problems with Arista, or real fears that Cisco is catching up. I believe investors who buy this dip in Arista could be well rewarded over the next few quarters.


Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Leo Sun has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Arista Networks. The Motley Fool recommends Cisco Systems and Intel. The Motley Fool has a disclosure policy.