2023-09-03 12:00:00 ET
Summary
- Arista Networks has been a consistent outperformer against the S&P 500 over the past three years. Long-term buyers who held on steadfastly have benefited significantly.
- The company is a critical beneficiary of AI-driven growth, bolstering its near-term growth drivers. However, for how long more?
- Caution is urged as ANET's price action suggests it has failed to regain decisive control and may experience a steeper pullback.
- I argue why, while there isn't a sell signal yet for ANET stock, entering at the current levels could entail considerable pain. Be patient, and don't chase.
Investors in leading communications equipment market leader Arista Networks, Inc. ( ANET ) have benefited tremendously since bottoming out in May 2022. Over the past three years, ANET has also been an incredibly consistent outperformer against the S&P 500 ( SPX ) ( SPY ).
ANET/SPY price chart (weekly) (TradingView)
As seen above, ANET/SPY has a clear medium-term uptrend, well-supported by dip buyers rotating back into ANET at significant pullbacks. Therefore, earlier buyers in ANET who held on to their positions have benefited, sitting through the volatility against the market.
The wide-moat cloud and data center networking solutions provider is a critical beneficiary of the AI-driven growth pillars, providing investors confidence in buying steep pullbacks.
Despite that, I assessed yellow flags in ANET/SPY's price action, suggesting that it has failed to regain decisive control of its March 2023 highs as its momentum topped out.
Based on this week's price action, buyers attempted to stage a decisive breakout, which could drive further upside if successful. However, the price action has yet to be validated, suggesting investors should pay close attention to developments over the next few weeks.
I assessed that if ANET/SPY fails to regain upward momentum against its March highs, a steeper pullback following a significant top could follow, leading to substantial downside volatility.
ANET price chart (2-Day) (TradingView)
Looking at ANET's short-term price action demonstrates the strength of its uptrend bias, providing dip buyers with solid confidence in buying dips over the past year.
As seen above, dip buyers returned at steep pullbacks and defended previous selloffs close to the 50-period moving average or MA (blue line). Momentum investors then provided ammo to drive further upward recovery and upside as ANET continues to take out higher highs (a pivotal development to corroborate an uptrend bias).
With ANET re-testing a significant high close to the $200 level, I didn't glean an optimal entry point for buyers. Dip buyers aren't likely to buy aggressively at the current level as well. Coupled with the caution shown in the ANET/SPY chart, I urge investors to remain patient and not drawn into the current levels, which could subsequently form a bull trap.
ANET last traded at a forward EBITDA multiple of 23.3x or forward adjusted earnings multiple of 31x, well above its peers' median multiple of 12.3x and 17.5x, respectively (according to S&P Cap IQ data). Seeking Alpha Quant's "D" valuation grade corroborates its premium valuation, suggesting that Arista Networks needs to continue thriving to justify its premium valuation.
However, analysts' estimates suggest that much of its near- to medium-term growth could have been priced in. Arista Networks' revenue growth is expected to fall to 10.8% in FY24, down from this FY23's 31.2% YoY growth. It's also likely to be down significantly from FY22's 49% uptick, suggesting a significant growth normalization phase.
Therefore, I believe there are sufficient reasons to be cautious about chasing ANET's upward momentum at the current levels, even though there isn't any sell signal yet.
As such, I encourage investors to remain patient and remain on the sidelines for a steep pullback to digest its recent optimism before considering adding exposure.
Rating: Hold. Please note that a Hold rating is equivalent to a Neutral or Market Perform rating.
Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.
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For further details see:
Arista Networks: Growth Could Slow - Don't Get Caught Napping (Technical Analysis)