Will Arista Networks Keep Up Its High-Growth Pace?

Image source: Arista Networks.

The cloud-computing industry has been a major driver of technological innovations, helping to give users the flexibility to add capabilities without massive investments to build a proprietary in-house IT infrastructure. In order to serve customers with virtual networks, high-speed data centers are crucial, and Arista Networks has seen explosive growth from its work on data centers. Yet coming into Thursday's third-quarter financial report, Arista shareholders have had to deal with a substantial pullback on fears that the company's past high growth rates might slow. Let's take a closer look at Arista Networks and what's been going on with the company over the past quarter.

Stats on Arista Networks

Data source: Yahoo! Finance.

Will Arista Networks earnings keep climbing? Investors haven't stopped feeling optimistic about Arista earnings, boosting their third-quarter projections upward by $0.04 per share and raising estimates for 2015 and 2016 by about 7% to 8%. The stock, though, has moved in the opposite direction, falling 24% since late July.

Arista Networks' second-quarter results showed just how solid the company's growth has been recently. Sales soared 42% on strength from both the product category and the service category, and net income rose an even more impressive 64%. Both figures topped the consensus forecast among investors, and even though the company gave guidance that suggested a slow pace of future growth, the stock seemed to ignore those warning signs, given how Arista has routinely beaten its own guidance in the past.

Later in August, though, Arista Networks stock started to drop sharply. Part of the decline came from the overall market's poor performance, but some investors also became nervous that some of the huge technology companies that are among Arista's most important customers could cut back on their spending levels. Moreover, concerns about the state of the European economy weighed on sentiment.

However, Arista has huge potential to boost its presence throughout the tech and telecom industry. One analyst noted that telecom companies AT&T and Verizon are looking at initiatives that will require a big ramp-up in the number of data centers each uses, and Arista would be a natural place for the telecoms to look for support. Moreover, with Microsoft looking to grow its cloud business exponentially in the recent future, and that should actually increase the amount it spends on capital upgrades -- some of which should gravitate toward Arista's business.

Nevertheless, Arista faces a large threat on the legal front. In September, Arista's stock fell sharply after news that the International Trade Committee was leaning toward rival Cisco Systems position in a patent dispute between the two companies. At issue is whether certain patents that Cisco developed are enforceable against Arista, with Cisco arguing that former employees who later joined Arista integrated patent ideas into Arista products without proper licensing. Although the lawsuits are likely to take more than a year to resolve, even the hint that some patents might be enforceable after earlier stages of litigation had leaned toward Arista's position was enough to make investors even more nervous.

In Arista Networks' quarterly report, investors will need to look for updates on the litigation issue as well as confirming that nothing has happened to slow the data-center specialist's top- or bottom-line growth. Even after its share-price swoon, Arista's valuation is high enough that it needs to sustain its high-growth pace in order to reassure investors that its litigation risks are worth taking in exchange for the reward potential the company offers.

The article Will Arista Networks Keep Up Its High-Growth Pace? originally appeared on Fool.com.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Arista Networks. The Motley Fool owns shares of Microsoft. The Motley Fool recommends Cisco Systems and Verizon Communications. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.