With an average analyst rating of buy, Arista Networks is clearly an analyst favorite. But the analysts could be wrong. Is ANET overvalued at today's price of $158.5? Let's take a closer look at the fundamentals to find out.
Arista Networks has a P/E ratio of 32.5 based on its 12 month trailing earnings per share of $4.87. Considering its future earnings estimates of $6.72 per share, the stock's forward P/E ratio is 23.6. In comparison, the average P/E ratio of the Telecommunications sector is 18.85 and the average P/E ratio of the S&P 500 is 15.97.
Arista Networks's P/E ratio tells us how much investors are willing to pay for each dollar of the company's earnings. The problem with this metric is that it doesn't take into account the expected growth in earnings of the stock. Sometimes elevated P/E ratios can be justified by equally elevated growth expectations.
We can solve this inconsistency by dividing the company's trailing P/E ratio by its five year earnings growth estimate, which in this case gives us a 2.67 Price to Earnings Growth (PEG) ratio. Since the PEG ratio is greater than 1, the company's lofty valuation is not justified by its growth levels.
We can also compare the ratio of Arista Networks's market price to its book value, which gives us the price to book, or P/B ratio. A company's book value refers to its present equity value -- or what is left over when we subtract its liabilities from its assets. ANET has a P/B ratio of 9.16, with any figure close to or below one indicating a potentially undervalued company.
A comparison of the share price versus company earnings and book value should be balanced by an analysis of the company's ability to pay its liabilities. One popular metric is the Quick Ratio, or Acid Test, which is the company's current assets minus its inventory and prepaid expenses divided by its current liabilities. Arista Networks's quick ratio is 2.646. Generally speaking, a quick ratio above 1 signifies that the company is able to meet its liabilities.
Next up in our analysis is Arista Networks's levered free cash flow, which stands at $448.17 Million. This represents the cash that is available to the company after all of its expenses and income are accounted for -- including those that arise outside of its core business activities. This money can be used to re-invest in the business or to payout a dividend. For now, at least, Arista Networks has chosen the former.
With most indicators pointing at a higher than average valuation with uncertain growth prospects, most analysts are either wrong about Arista Networks, or their research has uncovered one or more qualitative reasons to invest in the stock. For example, the strength of the management team and their plan for executing the business strategy may have convinced some analysts to give less weight to traditional quantitative factors.
