The Internet of Things (IoT) market -- which includes wearables, smart appliances, drones, cars, and other objects connected to each other and the cloud -- is expected to be the next growth market for many tech companies. Cisco (NASDAQ:CSCO) expects the number of connected devices to double from 25 billion in 2015 to 50 billion in 2020, while IDC believes that the market will grow from $655.8 million in 2014 to $1.7 trillion in 2020.
But as the S&P 500 flirts with all-time highs, it can be tough to find any "undervalued" stocks in this space that haven't rallied substantially. However, two IoT stocks can still be considered cheap compared to their industry peers: Cisco and Sierra Wireless (NASDAQ:SWIR).
As one of the world's largest manufacturers of routers and switches, Cisco is a straightforward play on a more connected world. But the market for routers and switches is a saturated and slow-growth one. Sales of routers and switches, which account for almost half Cisco's revenue, declined 3% and 5% annually last quarter respectively.
However, Cisco has also been expanding into higher-margin collaboration, service provider video, and cybersecurity services. Those businesses, which were beefed up by various acquisitions, all posted double-digit sales growth and accounted for about 17% of Cisco's top line last quarter. Earlier this year, Cisco acquired IoT service platform provider Jasper Technologies, which became its new IoT Cloud Business Unit. Cisco's core strategy is to bundle these services with its routers, switches, and UCS (Unified Computing Systems) servers to widen its moat against potential challengers in each category.
It's not a high-growth strategy -- analysts expect Cisco's sales to stay flat this year, and for its earnings to rise about 2%. But as Cisco's higher margin businesses become a larger part of its portfolio, its earnings could rise by 10% annually over the next five years. That gives it a 5-year PEG ratio of 1.2. While that's still higher than the "undervalued" threshold of 1, it's still a fairly low PEG ratio for a mature tech company. Cisco's P/E of 15 is also much lower than the industry average of 25, and its forward yield of 3.4% should prop up the stock during any big downturns.
While Cisco is the safe and diversified way to invest in the IoT market, Sierra Wireless represents the riskier "pure play." Sierra is the world's largest manufacturer of 2G, 3G, and 4G LTE embedded modules and gateways, which connect objects to the IoT.
However, Sierra's sales have fallen in recent quarters due to lower enterprise spending, tough macro headwinds in certain markets, and competition from cheaper Chinese M2M (machine-to-machine) module makers. Its sales growth dropped from the double-digits to the single-digits last year, and have remained negative over the past three quarters.
Sales fell 1% annually last quarter, and non-GAAP earnings fell 26% as operating expenses rose 10%. But on the bright side, that sales decline was an improvement from its 5% decline in the previous quarter. Its non-GAAP gross margin also expanded from 32.4% a year ago to 33.8%, indicating that the competition wasn't running it into the ground.
Shares of Sierra plunged nearly 20% on Aug. 5 after it followed up that report with soft guidance. The company stated that "softer short term demand and tighter inventory management" with some OEM customers would cause its full-year numbers to come in at the low end of its prior guidance for earnings of $0.60-$0.90 per share on revenue of $630 million to $670 million. Analysts, on average, had expected earnings to rise 10% to $0.69 per share and for revenue to climb 6% to $645 million.
However, that steep sell-off reduced Sierra's forward P/E to about 20. Its closest rival, Telit Communications, trades at 30 times earnings. Sierra's 5-year PEG ratio has also fallen to 1.5, based on an estimated annual earnings growth of 16.5% over the next five years. Both ratios represent multi-year lows for the stock.
Are Cisco and Sierra Wireless right for you?
I personally prefer Cisco over Sierra as a long-term play on the IoT market, but Sierra could rebound as billions of additional objects come online. Therefore, investors interested in "cheap" IoT plays should take a closer look at both stocks.