Market Paying A High Multiple For This High-Growth Drone Stock

The share price of Ambarella Inc (NASDAQ: AMBA) has more than tripled since the beginning of 2014. Investors are paying a high price to get a piece of Ambarella, which supplies chips to action camera market leaders GoPro Inc (NASDAQ: GPRO) and Xiaomi.

But with such a big move in share price in such a short amount of time, how much is too much when it comes to Ambarella’s stock? And is the extreme growth potential worth the extreme premium that investors are paying?

Cramer’s Drone Thesis

According to CNBC personality Jim Cramer, investors have been flocking into Ambarella not because of the action camera potential, but because of the potential use of the company’s products in the coming drone revolution. “I think drones are gigantic and commercial,” Cramer said back in June. “People are understanding drones.”

Cramer sees potential for drone usage in weather, military and even pipeline monitoring applications.

GoPro’s Biggest Fan

Back in May, Dougherty & Company analyst Charles Anderson discussed GoPro’s potential to expand into the drone market as well. The GoPro quadcopter is scheduled for release in early 2016, and Anderson sees a major opportunity for GoPro and Ambarella.

According to Dougherty, leading Chinese quadcopter drone-maker DJI has projected sales of $1 billion in 2015. “If we assume DJI will have 80% market share this year and that the market will grow 50% in 2016, the addressable market is about $1.9 billion in 2016,” Anderson explains. He sees no reason why GoPro/Ambarella shouldn’t be well-positioned to capitalize on that market.

Analytics: Barrier To Entry

Stifel analyst Kevin Cassidy also recently commented on Ambarella. In a report last month, Cassidy praised the company’s advances in analytics, software that helps cameras make decisions. Ambarella management told Stifel that they expect to eventually have analytics technology inside all video processors rather than having to add it via software. “We see analytics as a critical barrier to entry for competitors,” Cassidy noted.

Value Versus Growth

Investors considering Ambarella stock find themselves asking the age old question: how much is too much to pay for rapid growth?

By most every valuation metric, shares of Ambarella currently trade at a hefty premium to the rest of the market. The stock’s current P/E ratio of 55.3, P/FCF of 54.1 and P/S ratio of 14.2 are all extremely high. However, once the company’s growth is factored in, Yahoo Finance’s 5-year forward PEG ratio projection for Ambarella is only 1.73, slightly above average for the S&P 500.

Stifel is projecting Ambarella’s revenue to nearly double from $218.3 million in fiscal 2015 to $404.0 million in fiscal 2017. Stifel has $115 price target for Ambarella based on a 33x multiple on the firm’s 2017 EPS estimate of $3.50. However, if the market continues to price Ambarella at its current elevated multiple of 55.3, the stock could climb as high as $193 by 2017.

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