This AI Stock Hasn't Caught Up to Its Fundamentals Yet. Is the Market Sleeping on It?

Most investors considering artificial intelligence (AI) stocks gravitate toward big names such as Nvidia, Broadcom, Advanced Micro Devices, and hyperscalers building large AI clusters. However, another company is playing a crucial role in creating the high-speed networks that deliver low-latency data in these clusters. Without the critical networking layer, even the fastest GPUs will not be able to handle large AI workloads meaningfully.

Meet Arista Networks (NYSE: ANET), a company well-positioned to benefit from the growing adoption of Ethernet networking instead of proprietary InfiniBand networks globally. The third quarter of its fiscal 2025 was the 19th consecutive record quarter, with revenue soaring 27.5% year over year to $2.3 billion and non-GAAP net income jumping 25.1% to $962.3 million. These numbers are substantial, but the company's future growth prospects are even stronger.

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Arista shares trade at 47.5 times trailing earnings, which doesn't look undervalued at first glance. However, considering the AI networking opportunity and the company's exceptional revenue visibility, the fundamentals seem to be running even faster than the company's share price.

Here's why the market still doesn't seem to have understood Arista Networks' true potential.

AI networking opportunity

Hyperscalers have been increasingly building multi-petabit or gigawatt-scale data centers with multiplanar AI networks (multiple parallel network layers to handle different data traffic in an AI cluster independently) to support the synchronization of thousands of GPUs across large AI training and inferencing workloads.

Arista's high-performance, low-latency Ethernet switches and the Arista Extensible Operating System are now widely deployed in modern data center architectures. To meet surging networking demand, the company has expanded its hardware portfolio with the next-generation 800-gigabit R4 Series of networking switches, designed for AI clusters, cloud data centers, and scale-up environments. The company is thus one of the few networking vendors ready for the industry's transition from 400-gigabit to 800-gigabit and eventually to 1.6-terabit network speed.

Arista is also playing a crucial role in setting standards for open-source, interoperable Ethernet-based networks that can power large AI clusters through its work in Ultra Ethernet Consortium and Ethernet for Scale-Up networking projects.

Backed by these catalysts, Arista expects its AI-related networking revenue to be at least $1.5 billion in fiscal 2025 and $2.75 billion in 2026. The company also expects its target addressable market to be over $100 billion in the next few years. This highlights the company's significant growth potential in the networking space.

Hyperscaler deals

Arista's deep relationships with two major hyperscalers, Meta Platforms and Oracle, have become one of the company's strongest competitive advantages.

The company has co-developed the Disaggregated Scheduled Fabric (DSF), a two-layer, Ethernet-based networking architecture, with Meta Platforms to deliver predictable, congestion-free performance in large AI training clusters. Meta is already shifting its AI training clusters to this DSF networking architecture.

Wall Street seems to have noticed this tailwind. Research firm Evercore highlighted Arista's increasing role in data center networking and expects the company to account for 30% back-end cloud networking spend over the next few years. A meaningful portion of this growth is likely to come from Meta as it expands its data center footprint.

Oracle is also opting for high-performance Ethernet-based networking for its AI data centers, and has announced a collaboration with Arista as a part of its Oracle Acceleron platform.

Strong financials

Arista boasts a strong financial profile, with non-GAAP gross margin of 65.2% and non-GAAP operating margin of 48.6% in the third quarter. The company also has $10.1 billion in cash on the balance sheet and generated $1.3 billion in cash from operations in the third quarter.

Management expects Arista's revenue to grow 26% to 27% or $8.87 billion at the midpoint in fiscal 2025, followed by 20% year-over-year growth to $10.65 billion in revenue in fiscal 2026. Besides AI data centers, this also includes significant revenue contribution from the enterprise campus segment.

The company's acquisition of VeloCloud has further strengthened its campus network offerings. Dell'Oro analyst Mauricio Sanchez noted that this deal has added a production-proven and enterprise-grade software-defined wide-area network (SD-WAN) offering, a well-established sales channel, and over 20,000 customers to Arista's portfolio.

Arista's robust long-term outlook also highlights its confidence in its growth trajectory, despite macroeconomic worries and intensifying competition.

Valuation seems justified

Despite robust fundamentals, Arista's shares have tanked by about 18% in the past month. While the company surpassed consensus revenue and earnings estimates in the third quarter, investors seemed to be expecting an even stronger performance.

Investors are also worried about Nvidia's push into Ethernet networking with its Spectrum X platform and major wins with clients such as Meta Platforms and Oracle. Wall Street considers this a threat to Arista's growth.

However, this concern is misunderstood because it validates the bigger industry trend of a shift toward Ethernet networking. The available market opportunity is enormous, despite Nvidia's penetration with Spectrum-X Ethernet switches. Hence, none of these concerns points to a meaningful deterioration of Arista's long-term thesis.

Arista's premium valuation seems justified considering its 20%-plus growth rate for the next two years, despite its scale. The company's profit margins also look more like those of a software company than a traditional hardware company. Coupled with the standardization and rapid adoption of Ethernet networking, Arista can prove to be a smart yet understated pick now.

Manali Pradhan, CFA has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Advanced Micro Devices, Arista Networks, Meta Platforms, Nvidia, and Oracle. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.