Shares of cloud-networking switch provider Arista Networks (ANET 1.25%) were falling today, down about 3% as of 1 p.m. ET Tuesday on an otherwise positive day for the markets.
Arista reported its first-quarter earnings last night, and by all indications, the results were positive. Actually, the stock initially rose after-hours on Monday before falling into negative territory today. That could be due to the risk-off environment, and investors worrying about any company that sports a high price-to-earnings (P/E) multiple, rather than anything having to do with Arista's results.
In the first quarter, Arista's revenue rose a solid 31.4% to $877 million, with adjusted earnings per share of $0.84 rising 35.5% and also beating analyst expectations. Moreover, management gave a strong second-quarter outlook, with revenue rising sequentially to between $950 million and $1 billion.
Chief financial officer Ita Brennan said, "We are pleased with the continued growth of our enterprise business in the first quarter, combined with robust next generation product qualification and deployment activity with our cloud customers."
Arista is likely benefiting from the strong growth we've seen from the cloud computing giants, especially Microsoft (MSFT 0.08%), which is a huge Arista customer. Microsoft's Azure cloud grew 46% last quarter, and spending on the cloud appears to be strong even amid concerns over the economy.
So what exactly is the problem? It's hard to say; Arista is a hardware producer that actually trades at a pretty high P/E multiple, at 43 times trailing earnings and 32 times this year's estimates. With technology investors fretting over the path of the Federal Reserve's interest rate hikes and tomorrow's Fed meeting, tech companies with higher-than-average P/E multiples are tougher to buy, even if their business performance is solid, which seems to be the case here.
One other wrinkle could be that Arista guided for between 60% and 62% gross margins next quarter, compared with 63.1% gross margins last quarter. It might seem like a small difference, but could also lead investors to believe inflationary supply-chain woes will eat into the company's margin this year, holding back the company's earning power despite strong top-line growth.
It's a bit difficult to know what to do with strongly performing technology stocks like Arista. Generally, technology companies that are performing well trade at healthy valuations, and valuations are compressing as interest rates rise. Furthermore, there is also the risk of the Federal Reserve hiking interest rates too fast and pushing the economy into a downturn. That could hurt the capital investments by the large cloud companies if that happens, and therefore Arista's results.
Either way, it's a challenging environment for companies like Arista right now -- even if they are posting solid results and profitability.