Is Ambarella Stock a Buy?

Share prices of Ambarella (AMBA 0.49%) hit an all-time high after the chipmaker posted its second-quarter earnings on Aug. 31. Its revenue rose 58% year over year to $79.3 million, beating estimates by $3.4 million. Its non-GAAP net income rose more than sixfold to $13.1 million, or $0.35 per share, and beat estimates by a dime.

Ambarella might be a lesser-known chipmaker, but its stock has rallied more than 120% over the past 12 months. Let's see why it attracted so many bulls, and whether or not it still has more room to run.

Image source: Getty Images.

A brief history of Ambarella

Ambarella designs image processing SoCs (system on chips) and computer vision chips. Its image-processing SoCs process photos and videos for cameras, drones, and other gadgets, while its computer vision chips help security cameras identify faces, help driverless vehicles avoid obstacles, and enable other devices to process AI-related tasks.

Six years ago, Ambarella's top customer was GoPro (GPRO 5.92%). However, GoPro's growth stalled out, and its subsequent decline torpedoed Ambarella's stock.

Ambarella pivoted away from GoPro by focusing on the security camera and automotive markets. However, the Trump administration blacklisted several of Ambarella's top security camera customers in China last year, and it faced escalating competition from Intel (INTC -0.38%) -- which had expanded into the computer vision market with its acquisitions of Movidius and Mobileye. 

The pandemic also disrupted the automotive market last year, and Ambarella remains heavily exposed to chip shortages since it's a fabless chipmaker that outsources its production to third-party foundries.

How Ambarella silenced the bears

All those challenges made Ambarella seem like a weak investment. However, its year-over-year revenue growth actually accelerated over the past three quarters as its gross margins stabilized:

YOY = Year over year. Source: Ambarella. *Gross margin results are on a non-GAAP basis.

Ambarella expects its revenue to rise 57%-64% year over year in the third quarter, and for its non-GAAP gross margin to stay between 61%-63%. Wall Street expects Ambarella's revenue and non-GAAP earnings to grow 35% and 185%, respectively, for the full year.

That would mark a major turnaround from its 3% revenue decline and 52% earnings drop last year. Analysts expect its revenue and earnings to rise another 16% and 34%, respectively, in fiscal 2023.

Ambarella mainly attributes that recovery to the growth of its automotive and Internet of Things (IoT) camera markets. Its security camera business in China also stabilized as new customers replaced its blacklisted ones and it gained new customers outside of China.

Ambarella doesn't expect the chip shortage to ease anytime soon, but it still expects the automotive market's gradual recovery, along with demand for more advanced vehicles, to drive its long-term growth.

Ambarella didn't mention Intel in its latest conference calls, but it's likely that Intel's recent strategic shift -- which prioritizes the expansion of its foundries and catching up to Taiwan Semiconductor Manufacturing in the process race instead of the expansion of its non-core businesses -- has made it less of a threat to Ambarella.

But does Ambarella's stock still have room to run?

I was bearish on Ambarella for years, so its performance over the past year caught me by surprise. However, the stock has gotten a bit overheated at 105 times forward earnings and 16 times this year's sales, so it seems doubtful it will replicate those big gains anytime soon.

That being said, Ambarella successfully weathered some severe headwinds over the past six years and repeatedly silenced the critics, who claimed its business would be rendered obsolete by larger chipmakers.

Ambarella has clearly carved out a defensible niche with its image processing SoCs and computer vision chips, and it should continue profiting from the growth of the automotive and IoT camera markets. Therefore, I think Ambarella's stock might be worth nibbling on at these levels -- but investors should be mindful of its frothy valuations.