It's been a wild ride for Ambarella (NASDAQ:AMBA) shareholders. Though the stock rallied an impressive 73% in 2019, previous years weren't so kind: over the last trailing five-year stretch, shares are up a total of just 20%.

2019 was an important year, though. Ambarella has been transitioning away from its legacy high-definition video chips, used to power consumer tech like GoPro cameras and drones, and instead is focusing its attention on computer vision capabilities for use in things like security cameras, vehicles, and robotics.

Results are starting to roll in, which led to some renewed optimism last year, and early indications are that Ambarella could be back in growth mode. Expectations are riding exceptionally high -- which is keeping me from making a purchase just yet -- but the small chip company is worth putting back on watch lists.

An up-close picture of a camera aperture slightly opened.

Image source: Getty Images.

Sales back on the mend

After revenue and adjusted earnings per share fell 23% and 69%, respectively, in fiscal 2019 (the 12 months ended Jan. 31, 2019), fiscal 2020 didn't start much better. Sales continued to fall in the first two quarters, as legacy consumer product sales weighed on results.

Ambarella turned a corner in Q3, though. Management has reported that more than 50 customers were in pre-production planning using computer vision chips, leading to another rosy outlook for Q4 2020 as well.

Period

Revenue

Increase (Decrease)

Q1 2020

$47.2 million

(17%)

Q2 2020

$56.4 million

(10%)

Q3 2020

$67.9 million

19%

Expected Q4 2020

$55.0 to $55.9 million

8% to 15%

Data source: Ambarella.

Ambarella CEO Fermi Wang and his team of top execs said that geopolitical issues were still creating uncertainty during the last report, but since then a truce has been called in the U.S.-China trade war. It isn't over yet, but any de-escalation should be good news for Ambarella since China is a primary market.

In the meantime, the company has been announcing new computer vision capabilities at a steady pace, powering tech like driver safety features on cars to advanced AI-powered security features on cameras -- all good stuff in the long-term that should help the company avoid the extreme boom-bust cycles it was in with niche consumer goods that turned out to be more of a fad than anything else.  

Looking for life at the bottom line

Ambarella is making its way out of the woods, but it isn't all the way out just yet. Though sales are headed north once again, expectations for profitability -- gross margin on product sold and on adjusted earnings -- still have a long way to go to getting back to where they were.

Period

Adjusted Gross Margin

Increase (Decrease)

Adjusted Earnings Per Share

Increase (Decrease)

Q1 2020

59.6%

(2.2 pp)

$0.01

(92%)

Q2 2020

58.1%

(3.3 pp)

$0.21

(16%)

Q3 2020

58.1%

(2.8 pp)

$0.32

52%

Expected Q4 2020

56.5% to 58.5%

(4.1 to 2.1 pp)

N/A

N/A

Pp = percentage point. Data source: Ambarella.

One would think that the higher-bred computer vision and AI hardware would lead to even higher profitability than ever before, but so far no dice. That could change as the 2020 calendar year progresses though, and is an important metric to watch.

Still, if business is on the mend, why not buy now? Because I think a great deal of future recovery is already priced in.

Ambarella currently trades for 44.0 times trailing 12-month free cash flow (money left after cash operating and capital expenses are paid for) and 112 times unadjusted forward earnings. Granted, that value will moderate, especially if the company can generate a better number than the $0.01 per share generated in Q1 of fiscal 2020. But in the meantime, the stock is expensive.  

At the end of the day, though, Ambarella's work on computer vision chips holds promise.

If this recovery is real, shares will be worth nibbling on again. But personally, I'm waiting for a pullback after the monster 73% rally posted last year before I bite.