Why We're Not Concerned Yet About Arista Networks Inc's (NYSE:ANET) 25% Share Price Plunge

Arista Networks Inc (NYSE:ANET) shareholders won't be pleased to see that the share price has had a very rough month, dropping 25% and undoing the prior period's positive performance. Longer-term, the stock has been solid despite a difficult 30 days, gaining 19% in the last year.

Although its price has dipped substantially, given close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 17x, you may still consider Arista Networks as a stock to avoid entirely with its 38x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

With earnings growth that's superior to most other companies of late, Arista Networks has been doing relatively well. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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Is There Enough Growth For Arista Networks?

Arista Networks' P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Retrospectively, the last year delivered an exceptional 35% gain to the company's bottom line. Pleasingly, EPS has also lifted 230% in aggregate from three years ago, thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Turning to the outlook, the next three years should generate growth of 15% per year as estimated by the analysts watching the company. That's shaping up to be materially higher than the 11% per year growth forecast for the broader market.

In light of this, it's understandable that Arista Networks' P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

What We Can Learn From Arista Networks' P/E?

Arista Networks' shares may have retreated, but its P/E is still flying high. 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 maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Arista Networks, and understanding should be part of your investment process.

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.