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What Is 400G Technology, and Should Investors Care?

By Nicholas Rossolillo – Updated Apr 15, 2019 at 8:46AM

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Insatiable demand for data is setting up another wave of data center and network build-out.

Data centers and the cloud-based computing they power have been one of the most successful investing themes in recent years. According to internet infrastructure supplier Cisco (CSCO -0.53%), that trend could continue. There are currently 4.8 billion internet users around the globe and nearly 29 billion connected devices, and over 80% of internet traffic is video. With more people, devices, and video crowding cyberspace every day, Cisco says the amount of internet data traffic could triple by 2022.

And that's where 400G comes in -- the next generation of tech powering data centers and all the new demands being placed on them. This will be the year 400G starts getting deployed, so it's time for investors to stock up ahead of the movement.

What is it?

The term 400G refers to the maximum speed of data transfer, or bandwidth; the "G" stands for Gbps, or gigabits per second. That makes 400G a fourfold jump in maximum data-transfer speed from the current maximum standard 100G. Besides being faster, 400G also has more lanes, allowing for more throughput (the amount of data that can be processed at one time). Put simply, think of data centers as a freeway interchange that receives and sends information to different destinations, and 400G is an upgrade to the interchange that provides more lanes and a faster speed limit.

But why the need for another upgrade? The 100G standards were just adopted just a few years ago, and many data centers are still undergoing upgrades. The reason for 400G has to do with the continued boom in traffic, especially as it relates to video and other high-capacity data transfers. The 400G data centers will help accommodate things like ultra-high-definition (4K) video streaming, new video-game and virtual-reality content, artificial intelligence, and mobile 5G networks, to name just a few examples.

A yellow ethernet cable connected into the back of an internet modem.

Image source: Getty Images.

How to capitalize on it

Besides investing in cloud computing companies themselves, one of the best ways to bet on 400G and the continued development of data centers is investing in the companies that help build and manage them. Cisco is the leader in this space. According to tech researcher IDC, the company had 54.4% of the global market share of ethernet switches (a key component of data centers). Cisco's market share for enterprise routers and services was 42.7% in the third quarter.

The company is coming off a healthy run over the last year. Sales were up 4.5% over the last trailing 12-month stretch, including an 8.3% increase during the company's fiscal 2019 first quarter. Revenues are expected to increase 5% to 7% during the next quarter, and there's potential for that to accelerate as Cisco expects to start shipping its new 400G family of equipment later in the year.

Cisco's forward P/E sits at a mere 14.1, a value compared with the S&P 500's forward P/E of 15.3.

But an even better play on 400G could be Arista Networks (ANET 2.36%), which according to IDC had only a 6.6% market share of ethernet switches in the third quarter of 2018. But that share is rising as year-over-year revenue grew 27.6%. Total sales were up 23% over the last 12 months, including a 28.7% increase in the third quarter of 2018. Though Arista is a smaller company than Cisco -- both in size and by percentage of market dominance -- it is a more focused endeavor on data center build-out and cloud computing. It, too, will begin shipping 400G platforms early in 2019.

After some rough going in the last year, Arista's stock trades at a forward P/E of 22.8. Though that is still a premium valuation, it could be a fair price to pay. Revenue is expected to increase at least 24% during the fourth quarter as 100G data center growth is still underway, which could mean a further uptick in growth later in the year as 400G shipments begin.

With the two leaders in data center build and support gearing up for a new generation of upgrades to support cutting-edge tech, 2019 looks like it could be a big year for 400G stocks. Pair that with a widespread pullback in technology stocks the last few months, and now is a good time to put Cisco and Arista Networks on your watchlist.

Check out the latest Cisco and Arista Networks earnings call transcripts.

Nicholas Rossolillo and his clients have no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Arista Networks. The Motley Fool has a disclosure policy.

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