Personal Finance

How Ambarella Inc Turns Its Patented Chips Into Gold

AMBA Gross Profit Margin (Quarterly) Chart

One of the key ways to find a winning investment is to seek out a company with pricing power. The ability to charge a premium price for one's products can lead to higher profit margins -- and in many cases, a higher stock price. Ambarella (NASDAQ: AMBA) consistently delivers quarterly gross profit margins in the mid-60% range. Here's how the chip supplier does it.

AMBA Gross Profit Margin (Quarterly) Chart

Source: YCharts.

InvenSense has 632 employees, of which 311 are in R&D. It operates in more of a commodity-type business, thus having to compete on price to win design sockets in customer applications. As a result, InvenSense has a much lower gross margin for the products it sells. Although both companies are fabless semiconductor companies, one clearly provides a unique product that is more profitable than the other.

A company such as Ambarella forms deep ties with its customers, helping fulfill design needs for future products. Evidence of the partnering is reflected in comments from last quarter's earnings report stating that -- although not material of late -- Ambarella engages in margin-sharing arrangements with one or more of its customers predicated on the customer's product margin where the SoCs are used. In other words, Ambarella can get more money if its customer sells the final product to end users at a higher price. This may happen when the customer believes they can charge more for a product based on any competitive advantages offered by Ambarella's chips.

Piling up the cash

Source: YCharts.

From an investor's perspective, when we find a company with pricing power, it can be wise to invest and allow time to be your friend. Although Ambarella's stock price has been volatile at times, it continues to add cash to its balance sheet on a quarterly basis, and in the long-term may well wind up rewarding the patient investor.

All too often we tend to sell too early in a company's life cycle, failing to let the story play out. As long as Ambarella can outperform competitors with its chips, the company will continue to dominate its space, and that should mean more cash pouring onto the balance sheet. Just keep your eye on gross margins staying in the mid-60% range and watch for cash flows to remain strong.

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Frank DiPietro owns shares of Ambarella. The Motley Fool owns shares of and recommends Ambarella. The Motley Fool owns shares of InvenSense. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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