The Internet of Things (IoT) -- which links mobile devices, wearables, smart appliances, connected cars, and other gadgets to the cloud and each other -- is expected to expand considerably over the next few years. Cisco (NASDAQ:CSCO) estimates that the number of connected devices will double from 25 billion in 2015 to 50 billion in 2020, and IDC estimates that the entire IoT market will grow from $655.8 million in 2014 to $1.7 trillion in 2020.
Those bullish forecasts prompted many companies to pin their future growth on the IoT market. But that hype also boosted the prices of many IoT-related stocks, making it tough to find undervalued plays in this growing market. Today, I'll highlight two IoT stocks that can still be considered cheap relative to their growth potential.
Analog semiconductor maker Skyworks Solutions (NASDAQ:SWKS) supplies RF chips for the mobile, automotive, broadband, wireless infrastructure, wearable, home automation, industrial, medical, and military markets. These chips are essential for many machine-to-machine communications that form the foundation of the IoT.
Skyworks believes that it will sell more chips for set-top boxes and media gateways, which will act as the central "hubs" for smart homes. It also believes that widespread 4G connectivity will boost its content share in mobile devices, since 4G devices require more of its analog chips than 3G ones. Simply put, the more things get connected to the Internet, the more chips Skyworks sells.
However, Skyworks' stock has fallen 17% over the past 12 months due to slowing sales of smartphones and its dependence on Apple (NASDAQ:AAPL). Skyworks doesn't disclose exactly how much revenue comes from Apple, but Oppenheimer & Co. analyst Richard Schafer estimates that orders for iDevices may account for 35% to 40% of its top line. But over the long term, Skyworks expects its dependence on mobile devices to decrease as other IoT devices take over.
Analysts expect Skyworks' revenue to rise less than 1% this year before rising 7.5% next year, fueled by its expansion into other IoT markets. Its earnings are expected to rise 4.9% this year, then continue growing at an average rate of 17% over the next five years. This gives it a 5-year PEG ratio of 0.8. Since a PEG ratio under 1 is considered undervalued, Skyworks looks cheap relative to its long-term earnings growth potential.
Qualcomm, the biggest mobile chipmaker in the world, is also well-poised to profit from the growth of the Internet of Things. With a well-established reputation for producing low-power, high-performance chips, Qualcomm can easily expand into adjacent markets like wearables, cars, drones, and smart home appliances.
Qualcomm has already released custom chips for many of these product categories, and it leads a consortium of companies known as the AllSeen Alliance, which uses Qualcomm's open source AllJoyn framework as a universal communications protocol for IoT devices. This ensures that smart devices from different companies can "speak" to each other.
Last year, Qualcomm acquired IoT chipmaker CSR for $2.4 billion to gain a major foothold in the connected cars market. In late September, several reports claimed that Qualcomm was in talks to acquire NXP Semiconductors (NASDAQ:NXPI), the largest automotive chipmaker in the world, for about $30 billion. If that deal goes through, Qualcomm could become the 800-pound gorilla in connected cars.
Qualcomm is doing all this because it is ceding market share in mobile chips to cheaper rivals like MediaTek and first-party chipmakers like Apple and Huawei. Like Skyworks, Qualcomm hopes to reduce its dependence on mobile devices with growth in a wider variety of IoT ones. Qualcomm doesn't regularly disclose how much revenue its IoT chipsets generate, but it claimed to have generated $1 billion in IoT chip sales in 2014. That figure only accounted for 4% of its revenues that year, but that percentage has likely risen following the acquisition of CSR and the introduction of custom Snapdragon chips for non-mobile devices.
Qualcomm's sales are expected to fall 8.3% this year, but rebound 2.3% next year on stronger sales of its new mobile and IoT chips. Its earnings, which are mainly supported by its higher-margin licensing business and buybacks, are expected to fall 7.7% this year but grow at an average rate of 10.5% over the next five years -- giving it a fairly low 5-year PEG ratio of 1.5.
The bottom line
The growth of the Internet of Things isn't guaranteed yet -- there are plenty of privacy, security, and reliability issues to iron out before "everything" gets safely connected to the cloud. But if Cisco's bullish forecast about the IoT is right, Skyworks Solutions and Qualcomm could generate a lot more revenue from non-mobile chips within the next few years.
Leo Sun owns shares of Cisco Systems. The Motley Fool owns shares of and recommends Apple, NXP Semiconductors, and Skyworks Solutions. The Motley Fool has the following options: long January 2018 $90 calls on Apple, short January 2018 $95 calls on Apple, and short January 2017 $75 calls on Skyworks Solutions. The Motley Fool recommends Cisco Systems. 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.
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