Nobody is perfect. That means every stock picker makes mistakes, and at some point, you will lose money on an investment. But if you do your research and build a portfolio of high-quality companies, you’ll likely have some big winners, too — monster stocks that grow to multiple times their current value.
Those big winners can help ease the pain of the losses from other stocks you might hold, because a stock can only lose 100% of its value, but there is no limit on the upside.
With that in mind, Arista Networks (NYSE:ANET) is a stock that can be the winning balance in your portfolio and has the potential to grow fourfold by 2030. Here’s why.
Strong competitive position
Traditional data centers run applications from a small number of servers, but the advent of cloud computing changed everything. In these environments, applications run across thousands of servers, and they are accessed by millions or even billions of people each day — think Facebook — meaning the aggregate bandwidth is much higher.
Unfortunately, legacy networks don’t offer the performance or programmability needed to support cloud computing. That problem created an opening for Arista Networks.
This tech company pioneered software-driven networking for cloud data centers and enterprise campus environments. Arista’s innovative methodology relies on software (rather than hardware) to control network traffic. This approach is more flexible and less costly than traditional solutions.
For instance, the core of Arista’s competitive advantage is its extensible operating system (EOS). This software powers all of its switching and routing platforms, from the cloud to the campus. By comparison, legacy hardware-defined solutions from rivals like Cisco Systems (NASDAQ:CSCO) require different operating systems in different environments, making things more complicated (and costly) for IT teams.
Not surprisingly, since 2012, Cisco’s market share in data center switching has fallen from 78% to 41%, while Arista’s market share has risen from 4% to 20%. More importantly, Arista is the market leader in terms of high-speed data-center switching platforms (i.e., 100 gigabits per second and above), and that’s the direction in which the industry is headed.
That advantage has already been a significant growth driver.
Q2 2017 (TTM)
Q2 2021 (TTM)
Free cash flow
To put those Arista figures in perspective, Cisco has grown revenue at less than 1% annually over the last four years, and its free cash flow has grown at just 3% annually. By comparison, Arista’s free cash flow margin (i.e., free cash flow as a percentage of revenue) currently sits at 33.2%, while Cisco’s is nearly four percentage points lower at 29.6%.
Big market opportunity
Looking ahead, Arista should benefit from industrywide tailwinds. Cloud computing will only become more important in the future as more enterprises move resources away from private data centers. This will drive demand for high-speed networking, and that’s where Arista dominates the market.
To that end, the company puts its market opportunity at $33 billion annually by 2025, and management is executing on a strong growth strategy. Last year, Arista acquired Awake Security, a company that specializes in network detection and response. Arista also acquired Big Switch Networks, a company that specializes in network monitoring. In both cases, these moves make Arista’s platform more robust, enabling it to address issues of critical importance (e.g., security and visibility) for data center operators.
Here’s the bottom line: Given Arista’s big market opportunity and strong competitive position, I think this stock could grow fourfold by 2030. If the company maintains sales growth of at least 17% per year over that period, the share price could quadruple without any change in the price-to-sales ratio, which currently looks reasonable at 11 times sales.
And if Arista does manage to pull this off, its market cap would hit $112 billion, which is still less than half of Cisco’s current market cap. That’s why this growth stock looks like a smart buy for long-term investors.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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