Following better-than-expected third-quarter results, Arista Networks' (NYSE:ANET) management anticipated double-digit revenue growth next year. In addition, the highly profitable cloud networking specialist has built a rock-solid balance sheet. So does that mean Arista stock is a buy?

Beyond the cloud

After several quarters of uncertainties because of the volatile quarterly spendings of a few giant cloud customers, Arista's long-term outlook looks brighter. 

Granted, Q3 revenue dropped 7.5% year over year to $605.4 million, but it exceeded the forecast range of $570 million to $590 million. Fourth-quarter revenue should also grow by 13.1% year over year, based on the midpoint of management's guidance range of $615 million to $635 million. These positive short-term results are due to the improved demand for the company's solutions across the entire portfolio. In particular, CFO Ita Brennan highlighted increased win rates with enterprises and service providers (telecommunication providers).

Looking forward, Brennan also indicated during the earnings call that she felt comfortable with analysts' projection of 13% to 14% revenue growth in 2021. And she expects the top line to keep growing beyond next year. Indeed, Arista's expanding portfolio should support that positive trend.

Cloud with computer servers in background

Image source: Getty Images.

The cloud market Arista addresses with its networking offerings should grow at a compound annual growth rate (CAGR) of 17.5% by 2025, according to the research outfit ResearchAndMarkets.

As an illustration, the cloud titans Facebook and Microsoft recently indicated sustained investments in their data centers. That bodes well for Arista, as Facebook and Microsoft represented 17% and 23% of revenue, respectively, in 2019. For instance, Facebook announced last week that it will increase its capital expenditure by 37.5% in 2021 (at the midpoint of its guidance range) to support investments in its data centers -- including networking infrastructure.

Besides, Arista estimates its total addressable market (TAM) will increase from $23 billion in 2021 to $33 billion in 2025, as it will be expanding beyond its core cloud networking offerings with networking software solutions and services. For example, the company developed campus (enterprises local networks) networking solutions that leverage the Wi-Fi and cybersecurity capabilities it recently acquired. Given Arista's success in disrupting cloud networking over the last several years, it's realistic to think the company could capture a part of the extra TAM its new adjacent networking areas represent.

A fair valuation

In addition to its attractive potential, Arista has been generating strong profits as it has been addressing giant cloud customers, which require reduced sales and marketing expenses. As an illustration, Q3 non-GAAP (adjusted) operating margin reached 38.2%, down from 39.4% in the prior-year period. Granted, management expects operating margins to decrease to 35% over the long term, as the company will be dealing with smaller customers by expanding into the campus area, but that long-term goal remains healthy.

Arista also maintained a rock-solid balance sheet. With $2.8 billion of cash, cash equivalent, and marketable securities at the end of Q3 (and no debt), it can face a potentially prolonged recession or proceed with acquisitions.

However, Arista's high valuation ratios already price strong performance going forward. Based on the midpoint of guidance, revenue should increase to $2.6 billion in 2021, which corresponds to 7.3 times the company's market cap of $19.0 billion. And the market values the company at an elevated price-to-earnings (P/E) ratio of 26.9.

Thus, Arista stock isn't a buy for me right now, but it remains an interesting tech stock to consider during the next potential market crash.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.