Key Points
Supply issues on various AI infrastructure components could pressure Arista's gross margins and hinder growth.
The stock is still expensive even after its share price dip.
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Shares of Arista Networks (NYSE: ANET) got slammed earlier this week after the networking company reported strong first-quarter results, but warned that supply constraints could affect revenue growth and gross margins moving the rest of the year and into 2027. The stock is still up about about 7.6% on the year and more than 55% over the past year, as of this writing.
Let's dig into Arista's results and guidance to see if this recent dip is a good opportunity to buy the stock.
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Supply constraints to pressure margins
While Arista turned in strong Q1 results and raised its guidance, management's comments about supply constraints sent the stock tumbling. Management said it expects a shortage of several data center components that is likely to persist for the foreseeable future, including wafers, memory, central processing units (CPUs), and optical components. It hopes that this will ease in a year or two, but right now the shortages are leading to higher costs to attain these items, which will pressure its gross margins.
Overall, Arista saw its Q1 revenue climb 25% year over year to $2.71 billion. That was ahead of its $2.6 billion forecast. Adjusted earnings per share (EPS), meanwhile, jumped 32% to $0.87. However, Arista began to see its gross margin contract in the quarter. Gross margin fell 180 basis points in the quarter to 61.9%, while adjusted gross margin, which excludes stock-based compensation, fell 170 basis points to 62.4%.
Arista relies heavily on hyperscalers, or companies with massive data center operations, which it calls Cloud Titans. Microsoft is its largest customer, accounting for around 26% of its revenue last year, while Meta Platforms accounted for 16%. Given the revenue concentration, Arista is not well positioned to pass along all the price pressures it is experiencing, which is why management expects to see some continued gross margin pressure. Meanwhile, it thinks it will soon be adding another one or two large customers.
Nonetheless, the company raised its full-year revenue forecast. It now expects revenue to grow by 27.7% this year to $11.5 billion, up from a prior outlook of 25% growth, or $11.25 billion. The growth is being driven by AI "fabric sales," which are now projected at $3.5 billion, up from its prior $3.25 billion guidance.
Is Arista stock a buy on the dip?
In essence, Arista is a networking middleman that assembles components into a nice package and layers its Extensible Operating System (EOS) software on top to make everything easier to manage. While the company should continue to benefit from strong AI data growth, right now, it is getting a bit squeezed in the middle, between large hyperscaler customers that want to keep costs down and rising component costs.
Even after the dip in its share price, the stock still trades at a forward price-to-earnings (P/E) ratio of 39.5 times 2026 analysts' estimates. Given the pressure it is under and its valuation, I think there are better AI stocks to own.
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Geoffrey Seiler has positions in Meta Platforms. The Motley Fool has positions in and recommends Arista Networks, Meta Platforms, and Microsoft. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
