Shares of video compression and computer vision chipmaker Ambarella (NASDAQ:AMBA) have put up a remarkable rebound this year. Pivoting away from the consumer electronics industry -- especially from former key customer and action camera maker GoPro -- has not been easy. Revenue has been declining since 2017 and continues to do so.

But optimism that the semiconductor's work in the field of computer vision will soon pay off has sent the stock on a near 70% rally so far in 2019. Second-quarter results did a lot to bolster that conviction in this technology stock, but one takeaway from the company's report could indicate the rally is overdone.  

Summing up the first half

Here's to flipping the script on the trade war between the U.S. and China: Where other chipmakers have struggled, Ambarella said it is picking up some extra business because of the dispute. Specifically, the White House's restriction on U.S. firms doing business with Huawei and its subsidiaries like fabless video compression semiconductor company HiSilicon has meant Ambarella is enjoying increased demand for its own video chips used in things like security cameras and cars.

A close-up picture of a camera's aperture.

Image source: Getty Images.

That helps explain how the video chipmaker was able to handily top expectations during the second quarter. And despite revenue still down year over year, and geopolitical headwinds and resulting tariffs still keeping all-out exuberance in check, management called for a pretty rosy outlook for its third quarter. Total revenue is expected to be $63 million to $67 million, compared with $57.3 million a year ago. All told, Ambarella could be all set to deliver a flat year for sales growth -- not great, but far better than the double-digit declines that have been the norm for some time now.

Metric

Six Months Ended July 31, 2019

Six Months Ended July 31, 2018

Change

Revenue

$103.6 million

$119.4 million

(13%)

Gross profit margin

58.2%

61.1%

(2.9 pp)

Operating expenses

$88.9 million

$89.5 million

(1%)

Net loss

($27.5 million)

($16.9 million)

N/A

Adjusted earnings per share

$0.22

$0.38

(42%)

Pp = percentage point. Data source: Ambarella.  

Here's the downside: Profits will still likely be solidly in the red, and free cash flow (revenue less cash operating expenses and capital expenditures) thin, made evident by falling gross profit margins and expected higher operating expenses in the third quarter. That's the scenario that likely kept management's optimism in check.

If you buy, know the company hasn't been

Besides issuing more language that the current geopolitical situation between the world's two largest economies makes forecasting difficult, Ambarella also reported another little tidbit that points to some caution on management's part. Despite having $50 million available under its share repurchase authorization in force through June 2020, no stock was purchased during the first half of the year. Over $68 million worth of stock was repurchased last year.

I think this is telling. As the company's stock continued to rise in price throughout the year even as revenue and profits (or lack thereof) continued to slip, management chose not to buy back any of its shares. For a high-growth tech outfit like Ambarella, share repurchases help offset the new stock the company issues to employees via stock-based compensation -- totaling $32.7 million so far this year alone. Just as a reminder, net new stock issuance means existing shareholders get less earnings per share they own -- when there are earnings to be had.  

Perhaps share repurchases will commence now that growth is back in the cards. However, the future is still cloudy, so the expected year-over-year advance in Q3 could promptly reverse course again. Maybe Ambarella had other places to use its cash that made more sense than share repurchases; or maybe the top team thought shares got ahead of themselves as far as valuation goes, opted for no stock purchases, and thus (unsuccessfully) timed the market; or maybe a combination of the two. Either way, though, the same decision was ultimately arrived at: The cash was better off being spent somewhere else.

I think investors will likely come to the same conclusion in short order. Ambarella trades for over 60 times 12-month free cash flow, a steep price for a chipmaker that is only cautiously issuing a growth outlook. But, if you bought in at any point in the last nine months, congratulations on making the right call -- I certainly didn't. However, chasing this one looks like quite the gambit. Computer vision will be a game-changer for Ambarella, but a great deal of that expectation is already priced in. With actual computer vision chips still not expected to contribute materially until next year, I'm still not quite ready to go spending on this one.