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Here's Why This Top Growth Stock Can Triple Once Again

By Harsh Chauhan - Sep 18, 2021 at 6:03AM

Key Points

  • Ambarella shares have taken off in the past year thanks to a string of terrific quarterly results on the back of huge demand for its computer vision chips.
  • Ambarella's guidance indicates that the company is about to step on the gas, which isn't surprising as more cameras per vehicle and new generations of security cameras are rapidly boosting its market.
  • Ambarella's earnings growth will improve big time over the next five years.

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The booming demand for chips used in automotive and security cameras will be a secular catalyst for this high-growth company.

Ambarella ( AMBA -0.22% ) stock has set the market on fire as its business has taken off thanks to the growing demand for security and automotive cameras. Shares of the company, whose computer vision chips power such cameras, have nearly tripled over the past year, with its latest fiscal 2022 second-quarter results (released on Aug. 31) playing a big role in that spike.

AMBA Chart

AMBA data by YCharts

Ambarella crushed Wall Street's estimates on the back of strong end-market demand as well as the company's entry into new markets. Let's see what worked for Ambarella last quarter and check why it can replicate its terrific stock market performance in the future as well.

Ambarella is on fire

Ambarella's Q2 revenue shot up 58% year over year to $79.3 million. Adjusted net income came in at $13.1 million, or $0.35 per share, a massive jump over the year-ago period's figure of $2.1 million, or $0.06 per share. Ambarella's explosive earnings growth was driven by a nice jump in the company's margins. It reported an increase of 450 basis points in the operating margin last quarter on the back of higher average selling prices.

Analysts expected Ambarella to deliver $0.25 per share in earnings on $75.7 million in revenue. The good news for investors is that the company looks all set to exceed expectations for a long time to come. That's evident from the company's guidance that calls for $90 million in revenue this quarter at the midpoint of the range, which is substantially higher than the $78.6 million analysts were looking for.

It is worth noting that Ambarella had delivered $56.1 million in revenue during the prior-year period, which means that it expects a 60% increase in the top line this quarter. That would be a step up from the company's performance last quarter.

Person with raised hands amid flying money bills.

Image source: Getty Images.

So, what's driving such impressive growth for Ambarella, especially considering that it was struggling just over a year ago? Ambarella credits the red-hot demand for camera chips for its turnaround. CEO Fermi Wang pointed out on the latest earnings conference call that Internet-of-Things security cameras and automotive cameras are driving substantial growth for the company. These two applications produced approximately 90% of the company's revenue last quarter. This bodes well for Ambarella as they are two fast-growing niches that should ensure long-term growth for the company.

Two big catalysts that could send the stock flying

The IoT-enabled security camera market is Ambarella's biggest source of revenue right now. The company estimates it will get approximately 60% of its fiscal 2021 revenue from this business.

Ambarella points out there were more than 900 million security cameras installed across the globe last year. However, most of them are older-generation cameras that are either analog in nature (first-generation) or networked cameras that need to be supervised by humans (second-generation). The third-generation security cameras powered by artificial intelligence have now started gaining traction and present a big opportunity for Ambarella.

The chipmaker explains that security cameras are upgraded after four to six years. The first-generation cameras are now being replaced and their market will continue to shrink. This bodes well for Ambarella as the chips used in a third-generation camera are twice as expensive as compared to the previous generation, which explains why the company has been witnessing an increase in the average selling price.

A third-party estimate points out that the IoT security camera market in Europe and North America could grow from 183 million units in 2019 to more than 420 million units by 2024. So, there's a massive opportunity for Ambarella to tap into and it is doing well to make the most of it. The company reported several new design wins last quarter with customers such as Bosch, two new customers in China, one new customer in Canada, and multiple design wins for its latest-generation chips that are currently in the sampling phase.

The automotive camera market, meanwhile, is expected to present a much bigger growth opportunity for Ambarella. The company estimates that the automotive market could hit nearly $5 billion in serviceable addressable market by fiscal 2026. That's not surprising as the number of cameras in cars is increasing rapidly. Ambarella points out that there was an average of 1.5 cameras on each car in 2020. However, future vehicles are reportedly going to be equipped with cameras in the double digits.

Ambarella is building up a robust pipeline of design wins to take advantage of the automotive camera market. The company had a $600 million design win pipeline in the automotive space at the end of October 2020, 65% of which was already secured by Ambarella. The remaining customers were a part of the bidding process. Now, Ambarella has announced fresh automotive design wins of late, so it is likely that its design win funnel has swelled further.

Terrific earnings growth is in the cards 

In all, Ambarella seems well positioned to sustain its high levels of growth in the coming years, so it is not surprising its earnings are expected to grow at a massive pace.

A compilation of analysts' estimates indicates that Ambarella's earnings could grow at an outstanding pace of 82% a year for the next five years. That's a big improvement over the negative earnings growth rate of 35% Ambarella has clocked in the past five years, and paves the way for Ambarella to sustain its hot rally and remain a top growth stock going forward.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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