One of the most important attributes any company can possess is a durable competitive advantage. Businesses that hope to outperform their peers need to be superior in some way. They need something that sets them apart from the pack. That could be a recognizable brand name, a better product, or a cost-efficient scale. Or it could be something more subtle, such as brilliant leadership or a great corporate culture.
Why does any of that matter? In my experience, businesses that have an edge often grow more quickly, operate more efficiently, and generate more cash. And those qualities tend to make the business unstoppable over the long term. Arista Networks (ANET 0.89%) and Union Pacific (UNP -0.08%) are two great examples. These companies have established strong competitive positions, and both stocks could make you richer in the years ahead.
1. Arista Networks
Arista pioneered software-driven networking for cloud data centers, an approach that does away with dedicated hardware and instead uses software to control network traffic. The company has since extended its technology to the broader enterprise campus, growing its market opportunity. Arista's core innovation is the Extensible Operating System (EOS), the software that powers its lineup of switching and routing platforms, offering the speed, programmability, and scalability that modern data centers demand.
Of particular importance, EOS runs across Arista's entire portfolio of hardware, allowing clients to deploy a seamless network across private and public clouds. By comparison, vendors like Cisco Systems use different operating systems in different environments, which increases cost and complexity. Arista further differentiates itself with CloudVision, software that delivers network-wide automation and monitoring from a single platform. Here again, Cisco requires its clients to use multiple management tools.
Put simply, Arista makes high-speed networking less complex and less costly, and that value proposition has translated into strong financial results. Over the past year, revenue rose 25% to $2.8 billion and earnings jumped 10% to $2.47 per diluted share. More importantly, Arista is well-positioned to grow its business even faster in the years ahead.
Specifically, Arista leads the high-speed data center switching market -- which includes ethernet switches offering throughput of at least 100 Gigabits per second (Gbps) -- and that's where the industry is headed. In the coming years, the continued adoption of cloud computing and the development of increasingly data-intensive applications will drive demand for faster and faster networking solutions.
On that note, management puts its addressable market at $33 billion by 2025, and given its strong competitive position, Arista should be able to capture a significant chunk of that figure. That's why this stock looks unstoppable.
2. Union Pacific
Union Pacific is one of seven Class I freight railroads in North America, a classification reserved for the largest rail carriers. Alongside Berkshire Hathaway's BNSF Railway, Union Pacific benefits from an effective duopoly in the western two-thirds of the U.S., where it works with over 10,000 customers and serves as a critical link in the global supply chain, transporting everything from food and automobiles to forest products and plastics.
Union Pacific's greatest asset is scale. The company operates over 32,400 route miles of track that connect the Pacific Coast and Gulf Coast ports with gateways to the Atlantic Coast, Canada, and Mexico, making it all but impossible for a new rival to enter the market. It would take too much time and cost too much money to build out competing infrastructure. But Union Pacific is also the only railroad serving all six major Mexico gateways, and it owns 55% of refrigerated boxcars in North America, giving the company an advantage in shipping perishable items.
In 2018, management introduced its Precision Scheduled Railroading (PSR) initiative, which aims to drive operational efficiency by making trains longer, moving freight faster, and optimizing workforce productivity. And in 2021, those strategies continued to pay off. Despite the winter storm in Texas and the impacts of the pandemic and supply chain disruptions, Union Pacific delivered solid financial results last year.
Total carloads (freight volume) increased 4%, which boosted revenue 12% to $21.8 billion. But profits grew twice as fast, soaring 26% to $9.95 per diluted share, as Union Pacific's focus on efficiency continued to drive margin expansion. In fact, its operating margin has jumped 550 basis points to 42.8% over the past three years.
Looking ahead, management says freight volume will grow more quickly than industry production, at roughly 3% per year through 2024, and the company believes it can raise prices more quickly than inflation. Moreover, management thinks Union Pacific will achieve an industry-leading operating ratio by 2023, which should drive low double-digit growth in earnings on an annual basis through 2024.
Here's the big picture: The transport of finished goods and raw materials is the backbone of the economy, and Union Pacific is a key player in global logistics. To that end, natural economic expansion should be a continuous tailwind for the company, and its focus on efficiency should drive increased profitability over time.