Buyer Beware: 2 Data Center Stocks That Look Overvalued Right Now

The data center industry is booming, and it's no wonder why. As cloud computing, big data, and artificial intelligence (AI) continue to shape our world, data centers are quickly becoming the engines behind our digital lives. The global data center market is projected to skyrocket to $437.3 billion by 2030, expanding at a 10.9% compound annual growth rate (CAGR).

Among the top contenders riding this wave are AAON, Inc. (AAON), known for its specialized HVAC systems crucial for cooling massive data centers, and Arista Networks, Inc. (ANET), a leader in high-speed networking solutions.

However, both AAON and ANET have exceeded the double-digit returns of the S&P 500 ($SPX) and Nasdaq Composite ($NASX) indices over the past year, and ended last week hovering near Wall Street’s average price targets. At current valuations, these stocks are looking pricey ahead of their upcoming earnings reports - even as both AAON and ANET offer compelling long-term upside in the data center industry.

Here’s why investors might want to keep these names on watch to buy on any dips.

Data Center Stock #1: AAON

Valued at $9.3 billion by market cap, Tulsa-based AAON, Inc. (AAON) designs, manufactures, markets, and sells top-notch heating and cooling equipment across the U.S. and Canada. Offering everything from rooftop units to geothermal heat pumps, the company serves diverse sectors, including retail, education, and healthcare.

A key player in AAON’s portfolio is BASX, a subsidiary that specializes in high-efficiency cooling solutions for data centers, enhancing performance and sustainability since its integration in 2021. With a strong sales network and a commitment to innovation, AAON keeps environments comfortable and efficient.

Shares of AAON have surged 100.8% over the past 52 weeks, rising 30.6% over the past three months alone. In fact, AAON hit its all-time high of $122.97 on Oct. 28.

AAON stock is currently priced at 50.43 times forward adjusted earnings and 7.57 times sales, well above both its industrial sector peers and its own five-year average multiples. This premium valuation reflects its recent wins and growth prospects, but the stock definitely isn’t cheap at current levels.

Notably, AAON also stands out for its commitment to passive income investors. The company has paid out dividends for 16 consecutive years.

On Sept. 27, AAON paid a quarterly dividend of $0.08 per share to its shareholders. AAON offers an annualized dividend of $0.32 per share, translating to a yield of 0.28%. The payout ratio stands at a low 13.66%, reflecting AAON’s dedication to rewarding its investors while continuing to grow and innovate.

AAON reported its fiscal Q2 earnings results on Aug. 1, sailing past Wall Street’s forecasts. Its total revenue rose 10.4% year over year to $313.6 million, beating estimates by 10.5%. The standout was the BASX segment, which reported a remarkable 58.3% sales growth, fueled primarily by booming demand for data center equipment. Its EPS climbed 12.7% annually to $0.62, also topping the analyst consensus by 14.8%.

As of June 30, AAON’s backlog hit a record $650 million, marking its third straight quarterly climb and a 23.5% year-over-year boost. The surge, fueled by BASX and Coil Products, reflects booming demand for AAON’s data center solutions.

CEO Gary Fields expressed confidence in AAON’s position, and stated, “The data center market continues to be robust and AAON is well positioned to take advantage of the growing opportunity. Beyond the bookings that made up the backlog at quarter-end, there remains a large pipeline of data center projects for both airside and liquid cooling products that the company is pursuing.”

What's Next for AAON Stock?

This week, AAON is expected to report its fiscal Q3 earnings on Thursday, Nov. 7, after the bell. Analysts tracking AAON estimate sales to be around $315.8 million, a 1.2% year-over-year uptick, while EPS is projected to be about $0.58, down 9.4% annually.

Looking ahead, analysts predict AAON’s EPS to rise 3.6% year over year to $2.28 in fiscal 2024, with the bottom line projected to surge another 20.6% to $2.75 per share in fiscal 2025.

On Oct. 25, AAON landed a significant milestone, securing approximately $174.5 million in orders from a major data center client. This deal involves crafting a custom thermal management system tailored for liquid cooling deployment, showcasing AAON’s expertise in this booming sector. The equipment, manufactured under the BASX brand, is set to roll out primarily in the first half of 2025.

Ahead of earnings, Baird upgraded AAON to “Outperform” and bumped its price target to a new Street-high of $130, with analyst Timothy Wojs writing that the new $175M data center order “is larger than AAON's (AAON) total data center business was in 2023.” 

AAON stock has a consensus “Moderate Buy” rating overall. Among the five analysts covering the stock, three suggest a “Strong Buy,” and two analysts have a “Hold” rating. The stock ended last week just 0.7% below the mean price target of $114.33.

Data Center Stock #2: Arista Networks

Incorporated in 2004, Arista Networks, Inc. (ANET) is a Santa Clara-based leader in crafting data-driven networking solutions for data centers, campuses, and routing environments worldwide. ANET is best known for its cutting-edge Ethernet switches and routing solutions, seamlessly blending hardware and software. Arista’s open architecture offers unparalleled customization, enhancing network flexibility by enabling diverse software to communicate efficiently. Its modular hardware allows hassle-free upgrades, making it a favorite in high-performance computing and data centers. 

With the new Universal Network Observability (UNO) feature on CloudVision, Arista enhances troubleshooting through AI-driven insights, solidifying its position as the go-to for AI data centers. Plus, Arista's partnership with Nvidia Corporation (NVDA) to create holistic AI data center solutions, slashing job completion times, further boosts ANET’s appeal.

Valued at $121.4 billion by market cap, ANET stock rose 87% over the past 52 weeks, with an impressive 54.5% surge in just the last six months.

Priced at 50.43 times forward earnings and 7.57 times forward sales, Arista Networks stock trades at a healthy premium to its own historical averages at current levels.

That said, ANET stock has been on the rise, fueled by impressive revenue expansion that reflects its growing influence in the networking sector. On July 30, the company released its strong-than-projected fiscal Q2 earnings results. Revenue climbed 15.9% annually to $1.7 billion, fueled by strong growth in the enterprise sector and its increasing influence in the booming AI hardware market.

Over the past year, its top line surged to $6.3 billion, a remarkable leap from just $2.4 billion in 2019. This upward trajectory has propelled operating income to more than triple, reaching $2.6 billion. Arista also reported a whopping FCF of $2.7 billion in the last year.

Its adjusted earnings per share skyrocketed 32.9% to $2.10, surpassing expectations by $0.16. With a dominant 81.3% of sales coming from the Americas, Arista is a powerhouse in the data center and cloud networking arena. Arista generated $1.5 billion of net cash from operating activities in the first six months of 2024, exiting the quarter with $2.4 billion in cash and cash equivalents.

As a pure-play networking company, Arista has its sights set on a staggering $70 billion total addressable market, hinting that its growth journey is just beginning. This potent combination of revenue growth and robust cash flow has investors excited, solidifying Arista's position as a key player poised for continued success in the dynamic tech landscape.

Can ANET Keep Rising After Q3 Earnings?

Arista is gearing up to release its fiscal Q3 earnings on Thursday, Nov. 7, after the market closes. Arista projects its revenues between $1.72 billion and $1.75 billion, with non-GAAP gross margins between 63% and 64% and operating margins at 44%. 

Analysts tracking ANET estimate its Q3 GAAP EPS to rise 14.1% year over year to $1.86, while its Q3 topline is projected to be around $1.8 billion.

For the full year, analysts expect the company’s GAAP profit to grow 21.2% to $7.42 per share, and then jump another 13.5% to $8.42 per share in fiscal 2025.

Last month, Citi raised its price target on ANET to $460 from $385, while maintaining a "Buy" rating. With predictions of a staggering 40% surge in capital expenditures among the top four cloud players, data center interconnect (DCI) providers like Arista stand to benefit significantly. As AI workloads grow, analysts see hyperscalers adopting multi-data center training approaches, making it unsustainable to contain massive AI model clusters in single data centers.

Citi's Atif Malik pointed out that tech giants are ramping up investments, with revenue for Arista projected to jump 25% in fiscal 2025, driven by Ethernet switching for AI networks.

Notably, Evercore analyst Amit Daryanani maintains an “Outperform” rating on Arista with a $400 price target. He suggests Arista could also score a $250 million revenue opportunity with Meta’s new GPU cluster. As AI continues to reshape the landscape, Arista’s position in this expanding market looks increasingly promising.

ANET stock has a consensus “Moderate Buy” rating overall. Among the 19 analysts covering the stock, 13 suggest a “Strong Buy,” one has a “Moderate Buy,” four advise a “Hold,” and one analyst recommends a “Strong Sell.” The stock closed last week marginally above its mean price target of $389.12.