By Jacob Sonenshine

Talk about a turnaround.

Shares in Arista Networks, the $119 billion maker of networking equipment, dropped by half from their January peak to a $64 bottom on April 4. That was worse than the S&P 500 index's 19% drop from its peak to bottom this year. Most of the decline was based on tariff-based fears and competitive concerns.

Recently, though, everything has gone Arista's way. The U.S. and China have agreed to roll back chunks of tariffs on each other's goods, while Microsoft and Meta Platforms -- which account for more than a third of the Santa Clara, Calif.--based company's sales -- both said in their first-quarter financial reports that they plan to grow their capital investments by double-digit percentages in 2025.

Some of the worst daily declines this year happened when the White House announced higher-than-expected tariffs, which threatened to slow the U.S. economy and could even have caused Big Tech companies to curb their longer-term artificial-intelligence investments. That would mean lower sales for companies like Arista, which supplies Big Tech's data centers with equipment. What was worse, the market has ongoing anxiety about "whitebox" competition, or the threat that Arista's customers could make their own equipment in a way that's cheaper.

Arista's stellar first quarter eased concerns about whitebox competition. Sales of $2 billion beat estimates of $1.97 billion, driven by better-than-expected product revenue of $1.69 billion. Its 27.6% year-over-year growth was driven by a 28.7% revenue gain in the $312 million service segment. The product side of the business grew just over 27%.

The growth brought adjusted earnings per share to 64 cents, 8% higher than the expected 59 cents. Costs rose about as much as sales, so the operating profit margin remained steady at just over 47%. The company repurchased stock, which reduces shares outstanding and increases EPS, but the tax rate was higher versus last year, keeping EPS growth from coming in higher than revenue growth.

The result demonstrates the type of growth the market wants to see. The stock fell 4.8% the day after the May 6 earnings release, partly because Microsoft's and Meta's bright outlooks were already priced in, but has since rallied to a recent $94.94.

This pattern -- in which the stock falls on competitive concerns, only to rebound as management proves doubters wrong -- is nothing new. Whitebox competition has been on investors' minds for years. The stock fell 17% in less than two months in early 2018, then gained 33% over the following year. It continued to rise for years thereafter, culminating in a more than 35-fold increase for its life as a public company since June 2014, crushing the S&P 500's threefold gain in that period.

"Arista has always faced the threat of whitebox," says Needham analyst Ryan Koontz. "They've proven year after year they're the leading innovator in their category."

According to FactSet, Arista has beaten earnings estimates in each of the past 20 quarters, led by the efforts of CEO Jayshree Ullal, an engineer who understands the product well and has run the company since its start in 2008.

"They [management] do a masterful job of managing [Wall] Street expectations," says Koontz, who calls Ullal a "product person, not a sales person."

The result is that Arista's products -- which focus on ethernet switches over InfiniBand -- will maintain their competitiveness for years. The latter technology accounted for most of switching demand as late as 2020, according to UBS analyst David Vogt. But ethernet has caught up, and now accounts for almost half the market.

"The general view is that InfiniBand is maxed out on market share and that ethernet is coming through," Koontz says.

Not only is ethernet -- especially "ultra ethernet," which provides higher speeds and fewer delays for data transfers -- gaining favor, but Arista has also increased its market share. It's now at almost 25% from just under 20% a few years ago, at the expense of competitor Cisco Systems, according to J.P. Morgan.

That isn't expected to change anytime soon. Cisco is more focused on legacy customers outside of the ones building data centers, and Koontz notes it would be too costly for Cisco to shift its focus to compete for Arista's main customers. Arista also won over another, as yet undisclosed, tech customer in the quarter, as it chases down a $29 billion long-term opportunity for AI products, according to Evercore.

That's why analysts forecast 19% annual total sales growth through 2027 to $11.7 billion, according to FactSet. Earnings per share are expected to grow at about 17% annually to $3.59.

That should push the stock higher. It trades at only 32 times expected earnings for the coming 12 months, below its peak this year of 51.9 times. It doesn't have to reach that to be a lucrative stock, but it should trade more richly as the company continues to turn in stellar growth each quarter. Vogt's discounted cash-flow valuation brings him to a 38 target multiple, as high-enough growth looks sustainable for about a decade, given the growth of Arista's customers' AI investments.

A 38 multiple would lift the stock by double-digit percentages. The average analyst price target for the end of the year is $109, or 15% upside from the current price. Koontz has a Wall Street--high $130 target.

You haven't missed the rally. There's a lot more to come.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

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June 05, 2025 01:00 ET (05:00 GMT)

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