Ambarella (AMBA) has been quite the moneymaker for investors this year: AMBA stock has more than doubled, and has made InvestorPlace analyst Jon Markman look like the oracle of stock picking in our Best Stocks for 2015 contest.
But Ambarella stock has seen some short-term weakness even if the year-to-date performance of this particular semiconductor company has been stellar.
For instance, AMBA recently dipped below its 50-day moving average and is off nearly 20% from its June highs.
So what’s next for Ambarella? Is AMBA stock breaking down, or is it poised for another breakout?
The Bull Case for AMBA Stock
A look at the charts hints that Ambarella is oversold, with a Relative Strength Index reading in the 30’s.
Click to Enlarge Typically, this kind of pullback and low RSI after a big run hints at a pause before the next leg higher.
What’s more, the narrative behind AMBA is great not just for the returns, but for its contract as a supplier for GoPro (GPRO) cameras.
GPRO stock soared after its IPO and then pulled back sharply, but sentiment is back in its corner as GoPro stock has surged over 40% since March. Ambarella has been able to ride this optimism too, and should continue to do so for a while.
There’s also some big short interest in Ambarella stock right now, which means short squeeze potential after earnings in early September. As of the end of July, short interest was close to 30% of available shares.
It can be worrisome to see so many folks bet against a company, but remember that AMBA stock blew away both profit and revenue targets in June, and a similar report could be a big catalyst both for buyers and short covering in Ambarella.
The Bear Case Against Ambarella
Of course, those shorts could be right. Ambarella has a good history of revenue and profit expansion, sure, but the valuation is concerning.
Right now, AMBA stock trades at around 28 times next year’s earnings — awfully high for a chipmaker. Worse, it’s trading for 8 times next year’s revenue. That doesn’t leave a lot of room for error.
Also, the stock has recently dipped below its 50-day moving average and has seen pretty sharp profit-taking after its June report. Sure, Ambarella jumped about 30% or so in early June in anticipation of strong earnings, but AMBA stock gave it all back over the next few weeks. Then the stock moved higher to flirt with a slightly lower high, then steadily backtracked across late July and into August.
That’s not a good indicator of momentum for traders right now.
And let’s be clear: AMBA is a stock for traders, not for long-term potential. Semiconductor stocks have had their moment in the sun this year after plenty of consolidation; in the last several months, Avago (AVGO) bought rival Broadcom for $37 billion, NXP Semiconductors (NXP) merged with Freescale and Intel (INTC) acquired Altera for almost $17 billion.
But that kind of dealmaking and near-term interest from Wall Street doesn’t necessarily equal a long-term growth story. Investors need to think about the here and now with AMBA stock.
Now that much of the gains have been made, you can understand the motivations to take profits and move on to the next trade.
I remain skeptical that long-term projections about chip demand in Asia and elsewhere is reason enough to purchase any semiconductor company, be it AMBA or one of the big guys like Intel. However, I do think that there is still room for dealmaking in the near term, and that Ambarella is a prime target.
Furthermore, I think the strong fundamentals limit some of the risk. Sure, there is bound to be volatility, but at the end of the day this is actually a fast-growing company with something to offer beyond narrative or the hopes of an acquisition.
Thus, I’d feel comfortable slipping a jab and holding or adding responsibly to a position in AMBA stock here. Short squeeze potential is a double-edged sword, but I think the environment is ripe for a big report and move higher in September.
Just remember to watch your back, since this is clearly a fast-moving stock, and things can change in a hurry for Ambarella or any other tech momentum stock.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. As of this writing, he did not hold a position in any of the aforementioned securities. Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP.