The Internet of Things (IoT), which connects wearables, smart appliances, cars, and other gadgets to each other and the cloud, is widely expected to be the next big growth market for chipmakers. Networking giant Cisco estimates that the number of connected devices worldwide will double from 25 billion in 2015 to 50 billion in 2020 -- indicating that early movers in the market could reap big rewards over the next few years.
Many tech companies have highlighted the IoT market as a major growth opportunity, but it can be tough for investors to narrow down the best long-term plays. Today, we'll take a look at three IoT stocks which could potentially double over the next few years -- Sierra Wireless (NASDAQ:SWIR), Skyworks Solutions (NASDAQ:SWKS), and STMicroelectronics (NYSE:STM).
Sierra Wireless is the world's biggest manufacturer of 2G, 3G, and 4G embedded modules and gateways. Since these components are required for most machine-to-machine (M2M) communications, Sierra is often regarded as a "pure play" on the IoT market. Sierra faces rising competition from cheaper chipmakers, especially in China, but the company has scaled up over the past few years by acquiring smaller wireless connectivity players like AnyData, Maingate, Mobiquithings, and GenX Mobile.
Sierra recently broke a four-quarter streak of annual revenue declines with 13% sales growth in the fourth quarter, which helped it post 1% top line growth for fiscal 2016. That growth doesn't sound impressive, but analysts expect Sierra's revenue and non-GAAP earnings to respectively grow 7% and 22% this year as enterprise spending accelerates, macro headwinds fade, and competition from Chinese competitors wanes.
Sierra's low valuation indicates that its price could eventually double. Its EV/Sales ratio of 1.2 is very low relative to larger chipmakers like Texas Instruments, which has an EV/Sales ratio of 5.8. With an enterprise value of just over $600 million, it's also a lucrative takeover target for any tech company that wants to instantly establish a market-leading position in the M2M modules market.
Skyworks Solutions supplies RF (radio frequency) chips for the mobile, automotive, broadband, wireless infrastructure, home automation, industrial, and military markets. These chips are also widely used for M2M communications. Skyworks is primarily known as an Apple supplier, and Oppenheimer & Co. previously estimated that as much as 40% of its annual revenue came from chips for iDevices.
But looking ahead, Skyworks believes that higher sales of RF chips for IoT products like connected cars, smart home appliances, and wearables will eventually offset the weight of its mobile chips business. Skyworks' quarterly revenue has dipped annually for three straight quarters, but analysts believe that it will return to positive growth this quarter and post 9% sales growth for the full year thanks to robust iPhone orders and rising demand for IoT products.
Its non-GAAP earnings are also expected to improve 12% this year, partly due to a new $500 million buyback plan authorized in January. Skyworks trailing P/E of 19 is already lower than its industry average of 22, but its forward P/E of 14 looks even cheaper. That low valuation indicates that the stock could rise much higher over the next few years.
STMicroelectronics, the largest chipmaker in Europe, manufactures a wide variety of chips for the automotive, industrial, security, and consumer electronics industries. Its automotive business is its largest unit, and has been lifted by rising demand for connected infotainment and navigation systems in higher-end vehicles. It also sells motion sensors for mobile devices and consumer electronics.
STMicro's revenue has risen annually for the past two quarters, which broke a multi-year streak of revenue declines. That turnaround can be attributed to soaring demand for automotive chips and analog chips and sensors for consumer electronics, which offset weaker sales of microcontrollers and digital ICs. Analysts expect STMicro's revenue to rise 8% this year, and its non-GAAP earnings are expected to rise 128% on its return to top line growth.
STMicro trades at 20 times forward earnings, which only seems like a slight discount to the industry average of 22 for broad line semiconductor makers. However, analysts expect STMicro's earnings to grow at an average rate of 49% per year over the next five years -- which gives it a 5-year PEG ratio of 0.5. Since a PEG ratio under 1 is considered undervalued, STMicro looks very cheap relative to its long-term earnings growth potential. That low valuation also makes STMicro a very lucrative takeover target for bigger chipmakers that want to diversify into automotive chips.
The key takeaway
Sierra Wireless, Skyworks, and STMicro should all benefit from the growth of the IoT market, and their low valuations indicate that they have room to grow. I don't believe that these three stocks will double within a few quarters, but I think that they might do so over several years as demand for their components heats up.
Before investing in stocks, here is some advice to help beginners choose the right ones.
Leo Sun owns shares of Cisco Systems. The Motley Fool owns shares of and recommends Apple, Sierra Wireless, and Skyworks Solutions. The Motley Fool has the following options: long January 2018 $90 calls on Apple, short January 2018 $95 calls on Apple, short August 2017 $87 calls on Skyworks Solutions, and short August 2017 $85 puts on Skyworks Solutions. The Motley Fool recommends Cisco Systems. The Motley Fool has a disclosure policy.