Arista Networks, Inc.'s (NYSE:ANET) Shares May Have Run Too Fast Too Soon

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 40.6x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

With its earnings growth in positive territory compared to the declining earnings of most other companies, Arista Networks has been doing quite well of late. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. If not, then existing shareholders might be a little nervous about the viability of the share price.

View our latest analysis for Arista Networks

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Arista Networks.

Does Growth Match The High P/E?

In order to justify its P/E ratio, Arista Networks would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered an exceptional 53% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 220% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Looking ahead now, EPS is anticipated to climb by 11% per annum during the coming three years according to the analysts following the company. With the market predicted to deliver 10% growth per year, the company is positioned for a comparable earnings result.

In light of this, it's curious that Arista Networks' P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

The Bottom Line On Arista Networks' P/E

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Arista Networks currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

It is also worth noting that we have found 1 warning sign for Arista Networks that you need to take into consideration.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.