Is Arista Networks (ANET) Stock a Buy For 2021?

Madison Investments, an independently-owned investment firm, published its third-quarter Madison Mid Cap Fund commentary – a copy of which can be downloaded here. During the third quarter of 2020, the Fund returned 6.72%, underperforming its benchmark, the Russell Midcap Index which returned 7.46% in the same period. You should check out Madison Investments’ top 5 stock picks for investors to buy right now, which could be the biggest winners of 2021.

In the Q3 2020 Investor Letter, Madison Investments highlighted a few stocks and Arista Networks Inc. (NYSE:ANET) is one of them. Arista Networks Inc. (NYSE:ANET) is a computer networking company. In the last three months, Arista Networks Inc. (NYSE:ANET) stock gained 40% and on January 12th it had a closing price of $316.28. Here is what Madison Investments said:

“Our new investment this quarter is in Arista Networks, a leading innovator and seller of data center Ethernet network switches. Visualize a data center as consisting of rows and rows of computers, connected by wires and cables. It would be impractical, and probably physically impossible, to have a cable from every computer to every other computer. Therefore, cables are set up in a mesh pattern with metal boxes which act as intersections, or nodes, thus reducing the number of cables that need to be connected to a specific computer. Those metal boxes are called switches.

An Ethernet switch’s primary function is to direct data traffic along the proper path. As computer networks have grown in complexity, switches have come to incorporate increasingly sophisticated software in order to deal with the mushrooming traffic and network operating requirements. Thus, while Arista sells a physical box, its customers are really paying for the software IP that comes along with that box, which explains Arista’s very high 30%-plus operating margins.

The company was founded in 2004 by far-sighted engineers that saw the need for a new type of switch. Simply put, Arista’s switches are faster, more reliable, and easier to manage than the competition’s. These traits have always been important for data centers, but are even more paramount for cloud data centers, where the total network bandwidth is orders of magnitude higher than for legacy data centers. As the cloud exploded in growth, demand for Arista’s products followed. The company burst onto the scene over the past decade to claim the top market share among high-speed cloud network switches, and today, it has over $2 billion of revenues, with a target on its back from competitors that were caught flat-footed and are now intent on winning business away from the upstart. Over the past couple of years, its competitors have all introduced new products to compete with Arista, and the stock has slowly drifted down as investors remain concerned that it will lose share in the coming years.

We actually would be surprised if it didn’t lose a little share in the cloud data center market. Its products were so superior a few years ago during the last switch industry upgrade cycle, that some customers had almost no choice but to purchase almost 100% of their needs for certain portions of their network from Arista. A new upgrade cycle has started, and this time, with some viable alternatives available, some of those customers will no doubt add a second vendor. But Arista’s products remain superior, and we believe it will retain a fairly high share of its customers’ spend. End demand for the data center market overall should grow enough long-term that Arista should grow also, despite any temporary step-down in market share.

We are not relying on data center growth alone for growth. Another attraction is that over time, it seems inevitable that the demand for Arista’s leading edge switches will expand into adjacent markets. Data traffic is growing rapidly everywhere, not just in cloud networks. As that happens, those other networks will want the same things that cloud data centers want – leading edge speed, reliability, and ease of use. Some enterprise customers liked what Arista was doing for their data centers, so began asking it to offer products for their regular employee “campus” needs. Last year, Arista entered the enterprise campus market, and in just the first 12 months from launch, they sold over $100 million of products and services to that segment. The campus market is about the same size as the data center market, and thus doubles Arista’s opportunity set overnight. The company will need to lay more groundwork to penetrate this market; for example, it historically has called on prospects and customers directly with its own salesforce and service personnel, but the campus market is addressed primarily through distributors. So Arista must establish its network of distributors. This sort of infrastructure-building will take effort and will not be without hiccups, especially in a Covid-19 world of work-at-home.

Given all of these issues, the near-term is a little uncertain, but Arista remains the innovation leader and seems to have a long and durable road of profitable growth ahead. The company is cash-rich, with an excellent owner-operator management team that owns over one fifth of the company. We were able to purchase its stock at a very reasonable multiple.”

Pixabay/Public Domain

In October 2020, we published an article revealing that Giverny Capital is bullish on Arista Networks Inc. (NYSE:ANET) stock. The investment firm believes that the demand for cloud computing will continue to grow, creating a tailwind for Arista.

In Q2 2020, the number of bullish hedge fund positions on Arista Networks Inc. (NYSE:ANET) stock increased by about 38% from the previous quarter (see the chart here), so a number of other hedge fund managers believe in ANET’s growth potential. Our calculations showed that Arista Networks Inc. (NYSE:ANET) isn’t ranked among the 30 most popular stocks among hedge funds.

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Video: Top 5 Stocks Among Hedge Funds

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Disclosure: None. This article is originally published at Insider Monkey.