Shares of data center equipment designer Arista Networks (ANET -0.02%) have been on fire, more than doubling since the start of 2023. The fourth-quarter 2023 earnings update justified this company's dominant position in the market as the realization settles in that artificial intelligence (AI) -- or maybe just accelerated computing -- is more than just a passing fad.
But as Arista is ultimately a hardware-based business, periods of rapid growth can quickly come to an end. In fact, growth is expected to slow a bit for Arista in 2024. Is this still a top stock to bet on the future of data center and AI computing?
2023 was on fire, followed by a 2024 thud
2023 was an epic rebound for Arista. After several years of building to its AI supercomputing crescendo, the company put up incredible growth numbers -- with "Cloud Titan" customers Meta (META 0.43%) (21% of total revenue last year) and Microsoft (18% of revenue) leading the charge. A flurry of big tech businesses have been building out new data center infrastructure in support of accelerated computing, and Arista is a key partner in helping them put all the pieces together.
|
Financial Metric |
2023 Results |
YOY % Change |
|---|---|---|
|
Revenue |
$5.86 billion |
34% |
|
GAAP earnings per share (EPS) |
$6.58 |
54% |
|
Adjusted EPS |
$6.94 |
52% |
Data source: Arista Networks.
Data by YCharts.
In the chart above, you can see Arista's revenue and profitability really ratchet up in the wake of the pandemic. That's thanks in large part to the "Cloud Titan" customers (especially Microsoft and Meta) building and upgrading their data centers in support of all the new internet traffic they picked up the last few years. For Microsoft, that has been primarily its Azure cloud platform for businesses, and for Meta, its consumer-facing apps Facebook, Instagram, and WhatsApp needing to operate more traffic and launch new AI-powered advertising services for marketers. Arista's engineering teams have been busy helping both companies expand their data center capabilities.
But things could finally be starting to cool down in 2024, mostly due to the big data center customers moderating their spend on infrastructure (all together, including Meta and Microsoft, "Cloud Titans" accounted for 43% of total sales last year). Management said other enterprise customers should still grow, but the end result is a forecast for just 10% to 12% revenue growth in the year ahead. RW: Do these tables really add anything to the piece? We already mention the 10% to 12% forecast in the text and stacking these on top of each other might be more distracting than helpful. We could simply add this information into the text and alleviate some of the information bloat and we could make it more meaningful and clearer to less experienced readers in the process.
Growth is growth, so it's no big deal. After all, Arista is holding onto all of its big gains from the last few years. But the problem with a slowdown is that Arista stock now trades for a whopping 40 times trailing-12-month EPS and 42 times trailing-12-month free cash flow. That's about the highest valuation it has traded for in years, excluding during the pandemic when stocks went wild for a while. Is this really a good stock to buy right now, and is data center AI an enduring growth trend or not?
Arista's big advantage
For years, Arista has been gobbling up market share, especially at the expense of giant networking hardware leader Cisco. Cisco isn't exactly taking its eye off the ball, but it has been focused on software as of late. Remember its pending mega-acquisition of Splunk?
Because of this, and Arista's leading platform for network hardware and built-in software suite, I don't see any reason why the trend favoring Arista will change anytime soon, especially as new AI infrastructure (which Arista helps engineer, too) is further complicating data center needs going forward.
Image source: Arista Networks.
And while Arista is taking a cautious view to 2024, it is still confident in its ability to grow at a low-teens percentage clip over the long term. Along the way, it churns out high rates of profitability. At this point, the company has just over $5 billion in cash and investments on balance and no debt, which could fuel its ambitions.
Viewed in this light, Arista is a premium-priced stock, but reasonably so if you factor in excellent growth prospects over the next five years and beyond. I'm happy to hold my position, as Arista is a key partner for all sorts of data centers, and won't be dislodged easily as the AI era continues apace.
