The self-driving car market might be ready to (finally) reach an inflection point. The technology has advanced, and cars in select markets around the world are actually in commercial operation ferrying passengers without a driver behind the wheel. Exciting times!

Here's one small self-driving car and AI stock that often gets overlooked: Ambarella (AMBA 0.32%). Though it currently has a market cap of $3.3 billion, the chip designer has offered shareholders a wild ride over the last five years. But even with its ups and downs, Ambarella has actually done fairly well, doubling in value in that same time. Here's why it's worth watching in the second half of 2023.  

Downshifting now, but ready to zoom into the passing lane?

Chip companies can sustain growth if they embed themselves in a market with leading, patentable chip designs, and then layer new successful designs addressing adjacent markets on top of past successes. Historically, Ambarella hasn't quite been able to pull this off. Remember when its claim to fame was supplying GoPro (GPRO) with high-end video chips? 

Despite setbacks, though, Ambarella has managed to pivot away from consumer electronics and focus on new growth markets.  

These days, the company's video chip designs are found in automotive camera systems, video security cameras, and industrial applications like robotics. Some of these designs include software that helps computing systems to recognize objects. Basically, any device at the "network edge" (something that interacts with the real world) is Ambarella's target market for its small and power-efficient AI chips.

The company is also on its third-generation computer-vision AI chip for autonomous cars, dubbed CV3. This technology can also be used in security cameras with auto-recognition features and robots used in manufacturing automation.

But there's only one problem. The chip industry slump that began in the second half of 2022 has hit Ambarella hard. Revenue in its last quarter (ended April 2023) fell 31% year over year to $62 million. Free cash flow has been in decline as well as this tiny chip designer continues to struggle to reach a more robustly profitable scale.  

AMBA Revenue (TTM) Chart

Data by YCharts. TTM = trailing 12 months.

The good news, though, is that it appears the worst is now in the rearview mirror. Management expects next-quarter revenue to be as much as $64 million (roughly flat with last quarter), and profit margins should be up slightly from the last quarter.

Based on growing adoption of advanced driver assist systems (ADAS) and progressively better autonomous driving technology, Wall Street analysts' consensus is that Ambarella is back in double-digit revenue growth mode in calendar year 2024.  

Why watch the stock now?

Ambarella might look like a mess right now, but it's notable that it has been able to stave off lots of large competitors over the years -- including elements of Nvidia (NVDA 3.29%), Qualcomm (QCOM 1.85%), Huawei, NXP Semiconductor (NXPI 0.80%), Mobileye (MBLY 1.56%), and others. With each subsequent advance in its chip designs, Ambarella improves computing systems' ability to "see" and help customers make steady advances toward full driving autonomy.

Why keep an eye on Ambarella stock now? Like other semiconductor companies, it appears that business could start to heat up again in the back half of 2023. Elevated chip inventories are finally starting to normalize, and Ambarella could flip back to strong growth and re-start its profit generation very quickly.

Through this downturn, management has been able to protect the balance sheet. Ambarella had $227 million in cash and short-term investments, with zero debt, at the end of April 2023.  

Revenue directly tied to edge AI applications, including a commercial self-driving car customer, is now up to 60% of total revenue. Last year, AI was only about 45% of Ambarella's sales, according to management's estimates.

To be clear, I'm not buying right now. But this small chip designer has put in years of work to refocus its operations on longer-term secular growth trends: vehicle autonomy and edge device AI.

It's been over a year since I last took a closer look at Ambarella and decided to pass on it, but its efforts might be starting to pay off. Keep a close watch on this company the rest of this year.