Arista Networks (NYSE:ANET) and Juniper Networks (NYSE:JNPR) are both smaller players in the networking hardware market dominated by Cisco (NASDAQ:CSCO). Arista sells network switches and encourages customers to replace traditional routers by combining its switches and software in software-defined networking (SDN) deployments. Juniper, which sells both switches and routers, is a more traditional networking company like Cisco.

I compared Arista to Juniper back in late February and declared Juniper's lower valuation and higher yield made it a "safer" investment than Arista. But since then, Juniper's stock has dipped 3% as Arista's stock has risen 6%.

Let's see why Arista outperformed Juniper, and whether or not that trend will continue over the next few quarters.

A visualization of networking connections as seen from space.

Image source: Getty Images.

The current state of the networking market

Most networking equipment makers struggled this year as the COVID-19 pandemic shut down businesses and postponed network upgrades.

Cisco controlled 47.2% of the switch market and 33.2% of the router market in the second quarter of 2020, according to IDC. Cisco's shares of both markets declined from a year ago. Arista controlled 6.4% of the switch market, down from 7.3% a year earlier, and it ranked third behind Cisco and Huawei.

Juniper controlled 2.8% of the switch market, down from 2.9% last year, putting it in fifth place behind HPE. It also held 10.2% of the router market, versus 10.5% a year ago, ranking third behind Cisco and Huawei.

The only market leader that grew year-over-year was Huawei, which expanded its share of routers from 9.7% to 12%, and its share of switches from 31.1% to 36.3%. Huawei's growth was fueled by network upgrades in China, where regulators are barring American companies from major contracts amid the ongoing U.S.-China trade war.

Which company is growing faster?

Arista has consistently generated stronger revenue growth than Juniper over the past several years.

Revenue Growth (YOY)

2017

2018

2019

Arista Networks

46%

31%

12%

Juniper Networks

1%

(8%)

(4%)

Source: Annual reports. YOY = Year over year.

Arista's growth was buoyed by acquisitions, robust orders from cloud customers, and the growing popularity of SDN deployments, which are more flexible and scalable than traditional hardware-based deployments.

Juniper also expanded via acquisitions and launched new hardware for cloud services and SDN deployments, but it struggled to stand out in the saturated switch and router markets. As a result, Juniper generates lower gross margins than Arista, which enjoys an early mover's advantage in the SDN market, doesn't sell routers, and locks in customers with a sticky software platform called EOS.

Gross Margin

2017

2018

2019

Arista Networks

64.5%

63.8%

64.1%

Juniper Networks

61.1%

59%

58.9%

Source: Annual reports.

The growth rates and valuations

In the first half of 2020, Arista's revenue fell 12% year-over-year as the pandemic disrupted network upgrades. Its gross margin expanded from 64% to 64.2%, thanks to an increased mix of higher-margin software revenue, but its diluted EPS still fell 26%.

A network of cloud computing connections.

Image source: Getty Images.

Arista expects its third-quarter revenue to decline 10%-13% year-over-year and for its non-GAAP gross margin to hold steady. Analysts expect its revenue and earnings to decline 7% and 11%, respectively, this year then accelerate again with double-digit growth next year.

Juniper's revenue stayed flat year over year in the first nine months of 2020. Its gross margin dipped from 58.6% to 57.6%, due to a mix of lower-margin products and COVID-19-related costs, but its diluted EPS rose 36% as it cut costs during the crisis and repurchased more shares.

Juniper expects its fourth-quarter revenue to dip 1% year over year at the midpoint and for its non-GAAP gross margin to stabilize sequentially. Analysts expect its revenue and earnings to slip 1% and 11%, respectively, for the year as its expenses climb again in the fourth quarter. Juniper's growth is also expected to accelerate next year after the pandemic passes.

Based on those forecasts, Arista trades at 22 times forward earnings, which is higher than Juniper's forward P/E ratio of 13. Juniper also pays a forward dividend yield of 3.7%, while Arista doesn't pay a dividend.

The winner: Arista Networks

Juniper is still a cheap dividend stock, but Arista's higher gross margins, its forward-thinking approach to eliminating routers, and its focus on the SDN market make it a more resilient networking play. Therefore, Arista's stock will likely outperform Juniper's after the pandemic ends and customers resume their network upgrades.