This one’s going to sound a little familiar, but we’ll give it a quick once-over for the folks who haven’t been with Stock Gumshoe for long. The Motley Fool is pitching their flagship Stock Advisor newsletter ($59 for the first year, renews at ?) with a pitch about a company that they have “bet” on with their own money…. here’s the headline:

“We Have Over $1.5 Million Invested In This Stock

“Despite this company’s jaw-dropping success over the past few years, most investors have still never even heard of this company’s name!

“Act Now. Get Started Today!”

They do that a lot, actually, the Fool has a pretty substantial portfolio of owned stocks (and, rightly, discloses that ownership when they cover a company). Their position in this stock is now apparently worth $1.5 million, so it sounds like a big commitment, though we don’t get much context on that point — I don’t know what the size of the Fool’s investment portfolio is, or where this particular “bet” ranks in their holdings.

But they do tease away, and hint at their hope that this will be the next big winner for Stock Advisor:

“It’s been a heck of a run – but what we’re most proud of is our ability to consistently lead investors like you to some of the most life-changing investment returns the market has ever seen. I’m talking, of course, about companies like:

Amazon, rec’d 9/6/2002 (up 20,174%)
Netflix, rec’d 10/01/2004 (up 24,081%)
Nvidia, rec’d 4/15/2005 (up 37,596%)
Baidu, rec’d 10/18/2006 (up 1,252%)
Salesforce, rec’d 1/21/2009 (up 3,978%)

“These are actual investment recommendations we’ve shared with The Motley Fool community over the years – and the list goes on and on!”

The Fool’s “almost never sell” strategy means that Motley Fool Stock Advisor typically has hundreds of active “recommendations” in their portfolio, and those are real recommendations that the Gardner brothers made over the years and still recommend (though both brothers have now stepped back from picking stocks for the newsletters, I think)… and that’s been a big part of the Fool strategy, hold on to everything and count on the fact that a few very big winners will more than make up for the many disappointing performers. The math of it does clearly work, too, though I don’t know how many of their readers have been able to hold on to the big winners like that over time. It can be difficult, and sometimes even genuinely terrifying, for a retiree to have a position in NVDA shares, for example, that are up by even 1,000%, and hold on to get the current 25,000% gain, as they worry about such a richly valued stock becoming the largest part of their portfolio. We all think we’ll be great at managing huge wins, but it’s not so easy, particularly as these kinds of growth stock portfolios can naturally become very concentrated over time.

But yes, they have picked some big winners over the years. Will this be the next one? Let’s review the clues they drop to see which stock this is…

“… we’re not here to take a victory lap or make you feel bad if you missed out on any of these huge gains…

“Instead, we’re writing you today to talk to you about a small, California-based company that is pioneering a breakthrough technology that is enabling companies to move vast quantities of data over the Internet at lightning speeds.”

OK, that sounds like some extremely familiar language. What else do they tell us about this stock?

“And as the world has become more and more reliant on the Internet for everyday needs, this company has seen its revenue explode. The intense demand for this technology has helped the company race from zero to $1 billion in sales in just eight years.

“In fact, many of technology’s biggest names – including Microsoft, Alphabet, and Amazon.com – are now loyal, paying customers of this company.”

And…

“… we believe in this company so much, we even invited their CEO to Motley Fool Headquarters to personally tell her how much we believe in her company and why we are staking over $1.5 Million of The Motley Fool’s own money on their stock.”

So yes, the Motley Fool has been recommending this particular stock for six years or so, at least since the first time I wrote about them teasing the stock in the fall of 2017, and I’d say the time during which it was most aggressively touted by Tom Gardner and the Fool was in 2018 and 2019 (when their push probably helped the shares to trade at 70-100X earnings for a while). For much of the time from 2018-2020, we were peppered with alternating Motley Fool teaser pitches for Arista and The Trade Desk (TTD) seemingly every day.

Interestingly enough, either they’re getting lazy in updating their ads or they haven’t been re-recommending the stock recently — as of early 2020 they said they had issued 12 “buy” recommendations on this stock across Motley Fool services, and and more than a year ago it was at 14 “buy” recommendations… a number they seem to still be stuck at today.

The other numbers remain quite stale as well — the “eight years to a billion dollars in revenue” remains true, but that was level was breached many years ago now, Arista’s trailing revenue for the past four quarters is well over $5 billion.

And there’s been Motley Fool corporate money in the stock for a long time — it was teased as a $280,000 bet by Tom Gardner when they first recommended the stock back in 2017, and roughly doubled to $523,111 in their “double down” ads in 2018, and that’s the level they’ve used in similar ads over the past five years… though yes, if they just sat on their shares that they owned in 2018, that $523,111 would probably be worth well over $1.5 million now, since the stock has run from the $50-75 range that year to almost $275 recently.

The stock has had its ups and downs, but after doubling in the last year on the AI surge it is currently looking fantastic as a long-term performer — the company is Arista Networks (ANET), and this is how it has performed since Tom Gardner’s first “bet” on the company in the fall of 2017 (that’s ANET in purple, the S&P 500 in orange):

Here’s how Arista Networks describes itself, in case the name is new to you… their primary competitor is still giant Cisco Systems (CSCO), but there are also smaller companies like Juniper Networks (JNPR) in the picture:

“Arista Networks pioneered software-driven, cognitive cloud networking for large-scale datacenter and campus environments. Arista’s award-winning platforms redefine and deliver availability, agility, automation, analytics and security. At the core of Arista’s platform is the Extensible Operating System (EOS™), a ground-breaking network operating system with single-image consistency across hardware platforms, and a modern open core architecture enabling in-service upgrades and application extensibility. Arista has shipped more than fifty million cloud networking ports worldwide with CloudVision™ and EOS. The Arista team is comprised of experienced management and engineering talent from leading networking companies. Arista designs revolutionary products in California and delivers them worldwide through distribution partners, systems integrators and resellers with a strong dedication to partner and customer success.”

What’s going to happen next? ANET has posted earning “beats” most quarters, including six quarters in a row of pretty strong earnings growth above the analyst estimates, with data center spending rising… but it’s often the commentary about how they see they’re customers spending in the future that really drives the stock. Lately they’ve also been offering stronger guidance about the spending on 400G data center upgrades by the “cloud titans” who really drive most of Arista’s revenue, and as their role in the “AI revolution” has been chatted up more often, so optimism has been rising.

Here’s an excerpt of a analyst note summarized by SeekingAlpha back in August:

“Citi upgraded Arista Networks (NYSE:ANET) to Buy from Neutral and raised the price target on the shares to $220 from $177.

“Citi’s analysts expect 400G cloud spend to recover into next year as hyperscaler spending on traditional data center infrastructure recovers and a top customer’s capex re-accelerates….

“The firm also increased its FY24/25 EPS 10%/12% to reflect modestly stronger mid-teens topline growth and margin expansion for Arista.

“The analysts said they like Arista’s exposure to generative AI long-term and anticipate the stock’s multiple to rerate as 400G cloud spend rebounds, hyperscaler capex recovers, and opportunities to monetize generative AI materialize in the next year.”

And that spending has been picking up — a year ago we took a look at this stock, and at the time analysts were expecting $5.45 in adjusted earnings per share in 2023… now those same analysts are expecting $6.58 for the full year, with earnings growing at 10% in 2024 and antoher 15% in 2025. Of course, the typical analyst also had a price target of about $150 on the shares in January of 2023, when they were trading at around $120, and now the average target is about $245… while the stock has soared far beyond that, to about $275.

That means we’re looking at a forward PE of about 37 now, well above the 20X earnings valuation the stock carried before the AI mania took off.  They’ve clearly got momentum on their side, as spending on ramping up data center capacity also means more switches are needed, but they also face the fact that the “cloud titans” are growing to become an even larger part of the business.  42% of revenue coming from just two customers can lead to meaningful volatility, and that’s where Arista was last year (26% from Meta Platforms, 16% from Microsoft).  We’ll see how that might have changed in 2023 when they release their next 10-K, but the concentration is still very high (they are expected to announce their final 2023 earnings numbers next Monday, February 12, after the market close, and their 10-K Annual Report should come out around the same time)

We know that Microsoft has been disclosed as a “More than 10% of revenue” customer every year since 2018, and Meta/Facebook has often also been cited as a major customer, and the capital spending for data center equipment in that sector can be lumpy. That lumpiness has led to the waves of euphoria and disappointment with Arista Networks in the past, particularly when Meta/Facebook slashed its spending on Arista equipment in 2020 and 2021 before rebounding in 2022, but it does seem like spending is extremely robust in that area these days.  And investors have noticed, since they’re paying a much higher valuation for the shares.

That’s the biggest risk: that sudden pullbacks by their customers can wash away gains very quickly, and it’s not necessarily very predictable — that also happened with Arista in 2019, when they reported that one or two “cloud titans” paused their orders (it was widely thought to be Microsoft) and the stock was cut in half in the space of six months or so, with most of that coming in big “surprise” chunks of 20%+ after earnings disappointments. It has worked out well over time, but the stock has not ever spent much time on a smooth upward trajectory.  It doesn’t seem as though we’re likely to see big surprise pullbacks in data center spending right now, not with AI enthusiasm so high… but, well, that’s why these things are surprises — you don’t see them coming.

I’m not aware of any current problems in their business. Cisco (CSCO) has echoed Arista in being quite optimistic — the telecom and data center upgrades (to 5G and 400Gig, respectively), have created a pretty strong tailwind for years, and it’s true that the telecom companies are all talking about reducing capex and slowing their spending on 5G of late, that slowdown has been felt by most of the telecom suppliers over the past few quarters, but nobody’s talking all that cautiously about data centers right now… the most cautious comment was probably from Alphabet last week, and all they said was that they would be “responsible” with their data center capital spending.

From what I can tell, there’s no actual sign of caution in Arista’s data center order book just yet… but like I said, they do sometimes surprise investors, particularly when a huge customer changes behavior quickly. And we should note that Arista, as an investor favorite in recent years, is still competing with giant Cisco Systems (CSCO), which has 10X as much revenue. That contest has certainly been going Arista’s way in recent years, here’s the chart of the net income and revenue growth at those two companies, which, as you might imagine, has led to ANET stock dramatically outpacing CSCO stock…

Just note that you pay for that better growth, as usual — ANET is priced at about 37X expected earnings, with analysts guessing that they’ll grow their earnings by 10-15% per year in the future.  CSCO is priced at about 13X expected earnings (and also pays a slowly-growing dividend, current yield about 3%), with analysts guessing that they’ll grow earnings by less 5% per year.

What will happen next? Who knows.  A year ago there was a meaningful amount of concern that the big layoffs at big tech companies were going to lead to lower capital budgets, and slower growth of data centers, all part of the big belt-tightening to rightsize after the COVID mania. Today, those thoughts are washed cleanly from our minds, it’s all about who’s spending the most to ramp up their AI capacity and buy the most NVIDIA chips and develop the next attention-getting generative AI system, all of which takes lots of data center investment, which means more switches and routers and all that good stuff — preferably faster switches, as the 400G upgrades continue to take place and as more optical switching investments are made, all of which has generally been good news for Arista.

But that happened fast, a wild switch in the story over the past year, and that means the next narrative change could be jarring, too. When owning these fast movers, you have to be pretty comfortable with volatility and uncertainty.

Have any thoughts on Arista Networks that you’d like to share? Think they’re on a sustainable path now, or will they keep being buffeted by up-and-down order flow from Microsoft and the other biggies? Will Cisco stop losing market share to Arista and fight back, or is the sector growing so fast that both can become much larger? Let us know with a comment below… I’ve left the older comments attached from the last version of this article, too, just to give a little perspective.  Thanks for reading!

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Disclosure: Of the companies mentioned above, I own shares of Amazon, NVIDIA, The Trade Desk and Alphabet. I will not trade in any covered stock for at least three days after publication, per Stock Gumshoe’s trading rules.