Arista Networks, Inc.'s (NYSE:ANET) price-to-earnings (or "P/E") ratio of 41.9x might make it look like a strong sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 17x and even P/E's below 10x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Growth For Arista Networks?

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 42% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 228% 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 14% per year during the coming three years according to the analysts following the company. That's shaping up to be materially higher than the 10% per year growth forecast for the broader market.

With this information, we can see why Arista Networks is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Key Takeaway

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Arista Networks maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

The company's balance sheet is another key area for risk analysis. Our free balance sheet analysis for Arista Networks with six simple checks will allow you to discover any risks that could be an issue.

You might be able to find a better investment than Arista Networks. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.