Better Buy: GoPro Inc vs. Ambarella Inc

By Markets Fool.com

Image source: Getty Images.

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Throughout 2014 and 2015, action cameras became popular with extreme-sports enthusiasts. This year, interest has been piqued in a different arena. After several controversial police incidents across the country, many believeall law enforcement officers need to be equipped with body cameras.

At the forefront of these broad movement are two companies: GoPro (NASDAQ: GPRO)-- which manufactures the cameras, and Ambarella (NASDAQ: AMBA)-- which provides the software to make them work. But which is the better buy?

While there's no perfect way to answer that question, we'll look for the answer through three different lenses to get an idea.

Financial fortitude

In the business world, cash is king. While some investors want growth companies to plow all of their cash back into R&D, doing so makes a company fragile. If tough times hit and a company doesn't have enough cash on hand, it will be forced to reduce its operations, hoping just to live another day.

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Indeed, as the market for these cameras appeared to dry up last year, both Ambarella and GoPro benefited from healthy balance sheets. Here's where they stand now.

Company

Cash

Debt

Net Income

Free Cash Flow

GoPro

$280 M

$0

($214 M)

($95 M)

Ambarella

$324 M

$0

$59 M

$113 M

Data sources: Yahoo! Finance, SEC filings. Net income and FCF are in trailing-12-month format.

That last 12 months haven't been kind to either of these companies. GoPro's Hero 4 Session was a monumental flop, with the average selling price needing to be reduced twice just to move inventory. That had ripple effects on Ambarella as well since GoPro is one of its largest customers.

Both companies are lucky that they don't have any long-term debt -- as that could have been a death blow. But it's clear Ambarella is in a better position today; it's not hemorrhaging money right now the same way GoPro is.

Winner = Ambarella

Sustainable competitive advantages

Perhaps no variable is more important to the success of a long-term investment than the underlying company's sustainable competitive advantages. For both of these companies, such advantages are somewhat tough to come by.

In Ambarella's case, the advantages lie in the intellectual property the company owns via its codec software, but such software can be commoditized quickly. Even though Ambarella is working hard to diversify its offerings, the competition has much deeper pockets -- and more willingness to bleed the company out by cutting margins to the bare bone.

GoPro's key advantage is simply its brand name -- which has been somewhat tarnished since the failure of the Hero 4 Session. Currently, the company is trying to create an ecosystem that would create high switching costs -- one that includes original entertainment procurement and the use of editing software. But those efforts are in their nascent stage.

In the end, I don't think either of these companies has a particularly strong moat, but I'll give the nod to GoPro because the pathway to a viable ecosystem is at least present.

Winner = GoPro

Valuation

No measurement of valuation is perfect, but here are four I often reference before making a buy/sell decision.

Company

P/E

P/FCF

P/S

PEG Ratio

GoPro

N/A

N/A

1.5

0.6

Ambarella

20

17

6.3

1.7

Data sources: SEC filings, Yahoo! Finance, E*Trade. Non-GAAP EPS used to calculate P/E.

The data provide mixed messages. Ambarella looks like the clear winner on almost every metric given that GoPro has actually bled money over the past 12 months. But when we look at the PEG ratio, which takes future earnings growth into consideration, GoPro looks quite cheap. A PEG ratio of 1 is generally viewed as "fairly priced."

The success of GoPro lies squarely in its releases slated for the 2016 holiday season. The company is expected to release a Hero 5 camera, and its drone -- dubbed Karma -- in the second half of the year. The success of these two products will have an enormous impact on both the company and the stock.

Ambarella is clearly a safer bet based on valuation, but there's more upside potential for GoPro, so I'm calling this a tie.

Winner = Tie

If I were forced to choose...

As you can see, both Ambarella and GoPro came out ahead in one of the three categories. If I were forced to choose one of these as a better buy, I'd go with GoPro. Commoditization is the biggest threat to both of these companies, but I think it's more acute with Ambarella -- GoPro at least has the power of its brand to rely on. That happens to be why I own a small number of GoPro shares, but none of Ambarella.

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Brian Stoffel owns shares of GoPro. The Motley Fool owns shares of and recommends Ambarella and GoPro. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.