Should You Buy Ambarella (AMBA) Stock Ahead Of Earnings?

Shares of Ambarella, Inc. (NASDAQ:AMBA) slipped more than 2.3% in morning trading Wednesday, just one day before the company is set to report its third-quarter earnings results. But today’s slump seems attributable to an industry-wide tech selloff, so did investors just get a discount on AMBA ahead of its report date?

The glory days of Ambarella as one of Wall Street’s most talked about stocks are far gone, but as a leading producer of imaging semiconductors, the company is still an important bellwether for emerging trends like drone cameras.

In the second quarter, Ambarella exceeded expectations on the top and bottom line. The company reported adjusted earnings of 48 cents per share, beating our estimate of 45 cents but slumping more than 11% year-over-year. Revenues of $72 million were slightly ahead of our consensus estimate of $71 million and advanced about 10.8% from the prior-year quarter.

Based on our latest Zacks Consensus Estimate, we expect Ambarella to post earnings of 66 cents per share, which would represent a 40% slump from the year-ago quarter. Analysts are also calling for the company to report revenues of $89 million, down about 11.5% from last year.

Company management has already warned that this quarter was likely a challenging one, saying on its latest conference call that a “substantial decline in GoPro revenues and a moderate decline in the drone market” will impact top-line performance.

These challenges underscore a shift in Ambarella’s business model. In the previous fiscal year, action camera maker GoPro (NASDAQ:GPRO) was its largest customer, accounting for roughly 19% of its total revenues.

However, at the beginning of the current fiscal year, GoPro began purchasing chips from a competitor, putting a significant strain on AMBA’s revenue stream. Ambarella has also witnessed two consecutive quarters of declines in its drone segment.

But could investors be poised for profits if Ambarella can exceed expectations again this quarter? Well, if one wants to make an earnings play, it is best to gauge how likely a positive surprise is. For this, we turn to our proprietary Earnings ESP indicator.

The Zacks Earnings ESP (Expected Surprise Prediction) looks to find earnings surprises by focusing on the most recent analyst estimates. This is done because, generally speaking, when an analyst posts an estimate right before an earnings release, it means that they have fresh information which could potentially be more accurate than what analysts thought about a company two or three months ago.

A positive Earnings ESP paired with a Zacks Rank #3 (Hold) or better ranking helps us feel confident about the potential for an earnings beat. In fact, our 10-year backtest has revealed that this methodology has accurately produced a positive surprise 70% of the time.

Unfortunately, AMBA is sporting an Earnings ESP of -0.66% and a Zacks Rank #3 (Hold), so our model is inconclusive. Nevertheless, it is worth noting a few more things.

For one, Ambarella has been able to meet or exceed earnings estimates in every quarter since we started tracking the stock in mid-2014. But on the other hand, despite this outperformance, shares of AMBA have dipped in the wake of five straight earnings reports.

Today’s tech selloff may have provided investors with an opportunity to buy AMBA at a discount ahead of its report. That might give the stock a bit more room to climb if the earnings results are solid. However, AMBA has proven to be incredibly volatile around after its reports, and cautious investors may want to sit this one out.

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