Why Arista Networks Stock Rallied on Wednesday

Shares of data-center switch company Arista Networks (ANET 6.45%) rallied on Wednesday, gaining 7.2% as of 12:14 p.m. ET. Arista reported its first-quarter earnings last night, and they came in stronger than expected.

Solid guidance and positive commentary around the company’s artificial intelligence (AI) opportunity also quelled recent fears over competition.

Management remains confident in AI 

In the first quarter, revenue rose 16.3% to $1.57 billion, and adjusted earnings per share were up 39.2% to $1.99. Both numbers were ahead of analyst expectations.

Guidance was also stronger than expected at $1.62 billion to $1.65 billion in revenue, which would be good for 3.8% quarter-over-quarter growth at the midpoint, above the 2% quarter-over-quarter growth reported in the first quarter and amounting to an annualized rate of 16.2%. However, Arista typically forecasts conservatively and beats its own figures.

The company also authorized a new $1.2 billion share repurchase program, after it completed the previous $2 billion program last quarter.

Perhaps more important than anything, management remained confident in the company’s opportunity in AI. On the conference call, it highlighted a recent AI training cluster in which its ethernet-based switches provided a 10% improvement in job completion against the rival technology from InfiniBand, which is owned by AI leader Nvidia (NVDA -0.16%).

Not only have there been competitive concerns about InfiniBand versus the more standard ethernet technology, but last month one analyst also downgraded Arista on fears Nvidia would also begin producing its own ethernet switches. But management noted on the conference call with analysts:

We don’t see Nvidia as a direct competitor yet on the ethernet side. I think it’s 1% of their business. It’s 100% of our business. So we don’t worry about that overlap at all. 

Is Arista a Buy?

After today’s jump, Arista trades at a lofty 39 times this year’s earnings estimates, which is certainly not cheap. But it’s also not that expensive if the company can continue earning a 35% return on equity, as it does today, and if its 19% projected earnings growth over the next five years materializes.

However, the potential for Nvidia to enter the ethernet switching area is certainly a risk to watch. There doesn’t seem to be much of a threat yet, but it’s possible that could change in the quarters ahead.

Billy Duberstein has no position in any of the stocks mentioned. His clients may own shares of the companies mentioned. The Motley Fool has positions in and recommends Arista Networks and Nvidia. The Motley Fool has a disclosure policy.