Ambarella, Inc.'s (NASDAQ:AMBA) Business Is Yet to Catch Up With Its Share Price

You may think that with a price-to-sales (or "P/S") ratio of 7.4x Ambarella, Inc. (NASDAQ:AMBA) is a stock to avoid completely, seeing as almost half of all the Semiconductor companies in the United States have P/S ratios under 3.9x and even P/S lower than 1.8x aren't out of the ordinary. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

See our latest analysis for Ambarella

What Does Ambarella's Recent Performance Look Like?

While the industry has experienced revenue growth lately, Ambarella's revenue has gone into reverse gear, which is not great. One possibility is that the P/S ratio is high because investors think this poor revenue performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Keen to find out how analysts think Ambarella's future stacks up against the industry? In that case, our free report is a great place to start.

Do Revenue Forecasts Match The High P/S Ratio?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Ambarella's to be considered reasonable.

Taking a look back first, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 33%. At least revenue has managed not to go completely backwards from three years ago in aggregate, thanks to the earlier period of growth. So it appears to us that the company has had a mixed result in terms of growing revenue over that time.

Looking ahead now, revenue is anticipated to climb by 26% per annum during the coming three years according to the analysts following the company. Meanwhile, the rest of the industry is forecast to expand by 27% each year, which is not materially different.

In light of this, it's curious that Ambarella's P/S sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/S falls to levels more in line with the growth outlook.

The Final Word

It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Seeing as its revenues are forecast to grow in line with the wider industry, it would appear that Ambarella currently trades on a higher than expected P/S. Right now we are uncomfortable with the relatively high share price as the predicted future revenues aren't likely to support such positive sentiment for long. A positive change is needed in order to justify the current price-to-sales ratio.

You should always think about risks. Case in point, we've spotted 3 warning signs for Ambarella you should be aware of.

If these risks are making you reconsider your opinion on Ambarella, explore our interactive list of high quality stocks to get an idea of what else is out there.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.