When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 16x, you may consider Arista Networks, Inc. (NYSE:ANET) as a stock to avoid entirely with its 37.8x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
Recent times have been pleasing for Arista Networks as its earnings have risen in spite of the market's earnings going into reverse. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors' willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
See our latest analysis for Arista Networks
NYSE:ANET Price to Earnings Ratio vs Industry January 7th 2024
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What Are Growth Metrics Telling Us About The High P/E?
There's an inherent assumption that a company should far outperform the market for P/E ratios like Arista Networks' to be considered reasonable.
Taking a look back first, we see that the company grew earnings per share by an impressive 63% last year. Pleasingly, EPS has also lifted 161% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing earnings over that time.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 9.3% each year over the next three years. Meanwhile, the rest of the market is forecast to expand by 13% per annum, which is noticeably more attractive.
In light of this, it's alarming that Arista Networks' P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.
The Key Takeaway
Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.
We've established that Arista Networks currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.
We don't want to rain on the parade too much, but we did also find 1 warning sign for Arista Networks that you need to be mindful of.
If these risks are making you reconsider your opinion on Arista Networks, explore our interactive list of high quality stocks to get an idea of what else is out there.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.