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Ambarella Inc (AMBA) Stock Is on Fire: Should You Buy It?

For three years, HD video chip-maker Ambarella Inc (AMBA) was one of the hottest growth stocks on all of Wall Street. That distinction came to an unceremonious end last year, as AMBA crashed and burned, plunging from $125 per share to $33 per share.

But Ambarella is back. The stock has more than doubled from its 2016 lows, and currently trades around $69 per share.

Now up around 70 percent in the last three months, is AMBA stock a buy once again? Let's take a look.

The short-term outlook. Ambarella, which is known primarily as the supplier of HD video compression and image processing chips for GoPro (GPRO), has some bullish technical indicators going for it. Not only is AMBA trading well above its 50-day moving average of $56.94, but it's trading almost 50 percent above its 200-day moving average of $48.41, which suggests longer-term strength.

Also, because GoPro is by far Ambarella's biggest customer, Ambarella shares tend to trade in lockstep with GoPro's. Over the last year, that hasn't been so great: GoPro's revenue has been cratering, dragging GPRO stock (down 67 percent) and AMBA (down 20 percent) with it.

[See: Artificial Intelligence Stocks: 10 Companies Betting on AI.]

But a reversal of fortunes has been under way recently, and GoPro's 3-month, 60 percent rally has helped spark Ambarella's 70 percent gains over the same period.

Of course, GoPro's stock price isn't the thing potential AMBA shareholders should be paying attention to -- it's GoPro's underlying business strength, and what that means for Ambarella.

GoPro's big beat. On July 27, GoPro reported second-quarter results, which beat both top- and bottom-line expectations, adding fuel to an Ambarella stock rally that was already under way. GPRO reported a slimmer-than expected loss -- 52 cents versus 58 cents -- and blew the top off revenue expectations, which clocked in at $220.8 million against a $194.6 million consensus.

Ambarella doesn't break out the specifics, but Pacific Crest has estimated that sales to GoPro may account for as much as 25 percent of AMBA's 2016 revenue. And since the two companies have different fiscal years, GoPro's second-quarter results, which span from April to June, included two months of Ambarella's second quarter, which goes from May to July. Ambarella will announce its second-quarter results on Sept. 1, so investors have already seen that things are going smoothly at AMBA's biggest customer for two of the three quarters.

Other industries. AMBA, once essentially a pure-play on GoPro, has diversified its business over the years; today you can find its image-processing chips in security cameras, dashboard cameras in new-age cars, drones and wearables.

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When Ambarella reported first-quarter results in early June, for instance, it also beat analyst expectations for both EPS and revenue, despite an acknowledgement from CEO Fermi Wang that "near term headwinds continue in the wearable sports camera market."

Ambarella's strength in the drone market in particular has helped make it more of a multidimensional company and is helping to prop up gross margins. Its system-on-a-chip (SoC) technology can be found in the brand new Mi drones from Chinese tech company Xiaomi, released in May. DJI also uses Ambarella's technology in its drones, and so will the GoPro Karma drone when it's released later in 2016.

K C Ma, professor of finance at Stetson University, says Ambarella's presence in the drone market may even make it a takeover target.

"There is not a single company that makes an entire drone," Ma says. "Drone manufacturers get 80 percent of the parts of a drone from other companies, including chips, semiconductors, sensors and batteries for their product."

Over-segmentation like this may not last long if there are opportunities to vertically integrate, Ma says, noting that there have been rumors that Intel Corp. (INTC) and Qualcomm (QCOM) in particular may be eyeing AMBA as a takeover target.

High flier with high risk. AMBA stock is certainly flying higher at the moment, and if GoPro can execute a successful turnaround, that will go a long way in helping Ambarella's run continue. With no long-term debt on its books, exposure to several exciting growth industries, and its status as a potential buyout target, it's easy to see the long-term upside.

But Ambarella shares aren't cheap by traditional measures, trading at about 24 times forward earnings and a price-to-earnings-growth ratio around 1.85.

[Read: 7 Ways to Invest With a Theme in Mind.]

The company is bursting with potential and its short-term technicals look really attractive. For growth investors with a bit of patience, Ambarella shares look like a nice bet. But if you can't handle the risk -- and there's more than your average dose in AMBA -- this isn't the stock for you, and that's OK.

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