Three strikes and you’re out, right?
Not in my league – where we’ve got instant replay and it’s clear the umpire missed the call.
In this case we’ve got three “umpires” – and after checking the “tape” I’m convinced they all need new glasses.
Here’s what I’m talking about…
Between April 4 and 27 – after the end of the first quarter but before earnings were released – I watched as three brokers lowered their estimates on a company I’ve had my eye on for a while now.
It’s a maker of high-speed server switches and related networking software.
At the time, these umps were worried about two main things: continued growth and a patent battle with a networking rival. The “strike calls” came from…
- Credit Suisse,
- and Stifel.
Seeing a tech stock get three strike calls in three weeks like that would give most investors pause.
But we here know that sometimes you have to ignore the noise on Wall Street and dig deeper… check out the “instant replay”… and uncover whether there’s growth ahead or not.
So that’s what I did.
Turns out, this networking company had a superior earnings report. And according to my research deep dive, that patent dispute is a load of baloney.
Plus, I dug up five key reasons why this company’s stock has a whole lot of upside.
Let’s get into it…
Silicon Valley All-Star
Credit Suisse, Instinet, and Stifel glossed over one key fact about Arista Networks Inc. (NYSE: ANET).
It was founded by one of Silicon Valley’s top technologists of the past 35 years.
In 1982, Andy Bechtolsheim cofounded Sun Microsystems, a computing pioneer that invented the Java programming language and was later sold to Oracle Corp. (Nasdaq: ORCL) for $7.4 billion.
Bechtolsheim went on to be the first investor to fund Alphabet Inc. (Nasdaq: GOOGL).
Then, as a cofounder of Arista starting in 2004, he helped invent products and build a management team that has delivered 195% gains in just the past 19 months.
Now Arista finds itself enmeshed in patent battle with Cisco Systems Inc. (Nasdaq: CSCO).
Yes, Bechtolsheim and a couple of his Arista senior execs logged stints at Cisco. But Arista was founded more than a dozen years ago, long before this fight was even a thought in anyone’s heads.
More to the point, Bechtolsheim is known as a great inventor – so the likelihood that he infringed on Cisco’s patent is close to zero.
Plus, Arista has taken market share from Cisco because its high-speed Ethernet switches are better. On top of that, Arista has invented new software for its switches known as extensible operating system (EOS).
Adding this software to its lineup is a savvy move because it makes Arista’s hardware even more efficient. It’s a breakout move that makes Arista even stronger in the cloud computing market – a sector IBM Corp. (NYSE: IBM) says will be worth $200 billion by 2020.
To show you why Arista has so much upside ahead, let’s run it through my five filters for finding the best tech stocks – before they take off…
Rule No. 1: Great Companies Have Great Operations
We look for well-run firms with top-notch leaders.
Besides Bechtolsheim, who serves as chairman and chief development officer, Arista has another ace up its sleeve – it boasts one of Silicon Valley’s top networking experts as its CEO.
Jayshree Ullal formerly served as a senior vice president at Cisco, where she was in charge of $10 billion in sales from the firm’s Data Center Switches unit.
In 2015, Ullal received Ernst & Young’s “Entrepreneur of the Year” award. Three years before that, Forbes named her one of the nation’s “Top Executives” and trade magazine Network World named her one of the “50 Most Powerful People.”
Rule No. 2: Separate the Signal From the Noise
To create real wealth, you have to ignore the hype and find companies with rock-solid fundamentals.
As noted earlier, Arista received three downgrades – “strike calls” – in short order in April, with Wall Street worrying about those legal challenges from rival Cisco.
But right after that, Arista won a key federal rule that allows it to continue importing key gear needed for its product suite. The International Trade Commission may rule on that patent challenge from Cisco in September.
I’ve dug into the matter and I believe the chances that Cisco prevails are small at best. Once that’s cleared up, the stock should enjoy a nice bounce – and with this heads-up, you’re getting in before that happens.
Rule No. 3: Ride the Unstoppable Trends
We look for stocks in red-hot sectors because they offer the best chance for life-changing gains.
By investing in cloud players like Arista, you’re tapping several high-growth trends at once. After all, data centers factor heavily in everything from online video and music streaming to social networking and Big Data to smart homes and connected cars.
Whether it’s voice, data, text, or video, all that information must pass through at least one server farm, and quite often several. Arista is smart to move beyond its early focus on network switches in favor of its EOS software.
See, the software defined network (SDN) market is on fire, because all that code can access all types of hardware needed to run cloud centers. IDC says that from the base year of 2014 the SDN sector will grow by 54% a year through 2020, when it will be worth $12.5 billion.
Rule No. 4: Focus on Growth
Companies that have the strongest growth rates almost always offer the highest stock returns – so we dig in and find those.
We get a good sense here of a firm that still has plenty of runway left. Sales growth has remained stable for 13 quarters. Over the past three years, sales have climbed by an average 42%, doubling roughly every 18 months.
Yes, sales growth last quarter dipped slightly, to 38.5%. But that’s such a small change on a three-month basis, we simply don’t have enough data to suggest a slowdown here. More to the point, profits are still rising faster than sales – they were up 123% in the March quarter.
That’s important, because this is a tech leader that clearly knows how to manage its growth. It has just over $1 billion in cash on hand and modest debt of $39 million.
Rule No. 5: Target Stocks That Can Double Your Money
This is where we look at Arista’s earnings growth and see how long it will take to double profits. By doing that, we can figure out how long it should take for the stock to roughly double.
In the first quarter, net profits jumped by 123% and are expected to rise by nearly 20% for the June quarter. That gives us a nice way to be conservative with a firm that has grown earnings by 55% over the past three years – we’ll just cut the three-year rate in half and use 27.5% as our basis.
Now, let’s plug that into my Doubling Calculator. Divide the compound growth rate of 27.5 into 72 – and we find that the stock could double in a little more than 2.5 years.
With a market cap of $11.2 billion, Arista trades at roughly $156. It’s already got a great track record.
Because the stock sold off with the rest of the market in early February last year, it has gained 195%, or more than 5.5 times the S&P 500 over the same period.
Add it all up and you see why I say we ought to put our money behind Bechtolsheim and Arista.
He’s got a great track record – and he’s bound to hit us a home run over the next few years.