Today, dear friends, we start the week with… well, some guessing.
Lots of readers have asked about this latest ad from the Motley Fool Stock Advisor, so we’re going to dig in and see if we can get a good answer from the Thinkolator… but I’ll warn you up front that there aren’t enough clues to be definitive.
So let’s just dig in… Tom Gardner starts out, as all Fool pitches do, by mentioning the huge returns that Stock Advisor has shown from their best investments (12,345% from Amazon, 19,250% from Netflix, etc.), and then goes on to start hinting at his latest favorite:
“I’ve stumbled upon an under-the-radar stock I believe could be one of the greatest discoveries of my 25 years as a professional investor.
“I realize that’s a bold statement, so allow me to explain…
“This small, California-based company is pioneering breakthrough technology that is enabling companies to move vast quantities of data over the Internet at lightning speeds.
“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.”
Other clues? We’re told that Microsoft, Alphabet and Amazon are all customers of this company… and, of course, that “most investors have still never heard its name.”
And we’re told that he has recommended the stock a total of 12 times already… and that…
“I even invited their CEO to Motley Fool Headquarters to personally tell her how much I believe in her company and why I was staking $523,111 of The Motley Fool’s own money on their stock.”
So we know it’s a stock with a female CEO, and it’s one that the Motley Fool has not just recommended, but has actually bought.
So who’s this? Thinkolator says, with a rather tepid 85% likelihood, that this is Arista Networks (ANET).
Why Arista? Well, it is a cloud-focused networking equipment company, focused on the speedy movement of data… think Cisco (CSC)), but really focused on the biggest data center applications.
And it does have a female CEO in the pretty understated Jayshree Ullal, who was recruited from Cisco to get Arista going about ten years ago.
And we know that the Motley Fool has been investing in the stock, and that Tom Gardner himself had recommended it at least a couple times prior to a year ago, when it was the subject of a different Fool teaser ad. The Fool had only invested $280,000 at that time, but, depending on the actual price they paid, it could have been in the $533,000 neighborhood a couple weeks ago, when ANET was near all-time highs (or, of course, they could have invested more in the past year).
And when it comes to the one semi-specific clue, the “zero to $1 billion” in sales in eight years, that’s an equally semi-specific match — Arista did start selling their products in 2008, though they didn’t go public until 2014 (they were backed by some early Cisco scientists and Google investors, who bankrolled the first years of development), and they hit that billion-dollar level for annual sales late in 2016.
Interestingly, given that this is the tenth anniversary of the bankruptcy of Lehman Brothers, Lehman was actually their first big customer — the first wave of demand for this faster internet and faster data movement was among the high frequency traders, who could benefit from getting their data or placing their orders even a few milliseconds faster than the competition, and then other big companies who want to speed up their data started coming aboard. For a while they were plagued by back-and-forth patent infringement and intellectual property theft lawsuits with Cisco, but they settled most of that, at least temporarily, just a few weeks ago (part of the settlement was a 5-year embargo on most new litigation between the two, though there’s also still an outstanding appeal on their older copyright case — so it’s possible that the $400 million ANET paid in the settlement this year wont’t entirely be the end, but the big stuff seems taken care of for now).
I didn’t invest in Arista last year, sadly (it’s up a good 50% since I last wrote about them), but I summed it up as “hard to buy after a steep climb, but probably reasonably valued at a forward PE of 33 given the expectations of 20% earnings growth” — the stock then had a strong few months in setting new highs over the winter, but since then has been fairly flat as growth expectations have come down considerably.
So what to do now? Arista reported fairly unexciting earnings in early August (good, but not fantastic — which counts as “unexciting” when you have a trailing PE of 99), then the stock popped up a little bit later in the month thanks (probably) to that Cisco settlement, and, more importantly, to the company being added to the S&P 500 (which usually creates a bit of temporary buying pressure, since all the index funds have to buy shares)… but it has come down in the past few weeks as tech stocks have come under pressure, and as at least one analyst downgraded the stock.
Analysts are actually fairly tepid on Arista in general, maybe because they think Cisco is getting its act together and taking some business back from them — they were just downgraded to hold by Morgan Stanley, for example, and average analyst earnings estimates for ANET are now for 15% annual growth… and there are more “hold” ratings than “buy.”
The average price target is now $288, the same as it has been since February, so this seems like a stock where the analysts have long been cautious about valuation and have really only lifted their price targets to keep up with the market — so it’s going to have to be the next phase of surprising earnings growth that lifts the stock, I imagine, not some new excitement from Wall Street or another Motley Fool recommendation.
The risk for Arista, probably, is that they succumb to competition and lose some of their profit margin and see slowing revenue growth, like Juniper Networks (JNPR), the other “pretty big” Cisco competitor — Juniper is about half the size of Arista, but has more than twice Arista’s revenue, and is also expected to have earnings growth of 15% next year (though analysts see Juniper’s earnings growth slowing considerably to about 8% the following year). Arista is pretty clearly a stronger growth company, with more investor optimism and a technological lead and a strong customer base for their more focused offerings… but Juniper serves as a pretty useful warning sign of what could happen if earnings slow down more than expected for Arista — the stock is already mostly sitting still as investors and analysts chew on what kind of “deceleration” there will be in earnings growth, so this would be a bad time for the company to report a disappointing quarter or two.
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This Investors.com article sums up some of the analyst chatter about the race between Arista and Cisco to win “hyperscale” customers (like that aforementioned Microsoft, Alphabet and Amazon), much of it focused on who will win the first batch of customers for next-level 400-gigabit switches. Everything I read indicates that Arista still has an edge with these huge customers, but that there are plenty of risks — from Amazon developing its own switches to Cisco releasing next-generation switches a few months before Arista does.
So… color me still interested, but still not owning shares. “Decelerating growth” can lead to a lumpy stock market ride as investors who enjoyed Arista’s crazy surge in 2017 reset their expectations, so I will keep an eye on this one to see if we get some more selling that makes the price more attractive. The stock is trading at a forward PE of 31 and is expected to grow earnings at 15%, so that’s a PEG ratio of just about 2… which is probably reasonable, but not cheap.
That’s what I think, anyway — for your money, though, it’s your thought that counts, and I’m sure there are plenty of folks out there in Gumshoedom who are more intimately familiar with the horserace in high-end data center equipment. Does Arista get your gigabits buzzing, or is it too rich for your blood? Let us know with a comment below.
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