There's been a lot of hype about virtual reality in the past few years, but it's a pretty small business by tech standards. There are only a few million high-end headsets in use today and fewer than 10% of U.S. households have any kind of VR device. But the potential for VR continues to be extremely high and companies including Facebook (NASDAQ:FB), Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL), and Sony (NYSE:SNE) are betting billions on the future of the business. Here's why they're the three VR stocks to buy for 2018.
The biggest opportunity in virtual reality
I recently noted that Sony has by far the biggest installed base of VR headsets in the world, but I don't think it has the biggest opportunity. Facebook is where I see big potential.
Facebook's Oculus Rift is now selling faster than HTC's Vive, the other premium headset on the market, and in 2018 the company plans to launch a stand-alone VR headset called Oculus Go for $200, which could make virtual reality mainstream. Go will have only three degrees of freedom (how many ways a headset's positional or rotational movement is measured) in the headset, as opposed to the more accurate six degrees of freedom from Vive or Rift, but the experience could be good enough to show the capability of VR.
What Facebook is trying to build is the dominant VR platform, where it can act as a rent-seeking company, taking a percentage of every content sale on the platform. If Oculus Go is able to bring Facebook's install base up from under 1 million to at least 10 million, it would have a dominant position in the VR platform battle.
That'll be key late in 2018 when Oculus Santa Cruz, a premium stand-alone headset with six degrees of freedom tracking, is expected to be released. That's when the VR market could really take off.
When these new products are released, Oculus will be going after more than just VR gamers. Applications are being built for training, education, entertainment, and more, and the dollars at stake are staggering. According to market intelligence firm Superdata, the VR market will grow from $2.2 billion in 2017 to $28.5 billion in 2020 and even then adoption rates are only expected to be around 30% of consumers. If Oculus and Facebook can get their strategy right, they could have a huge business on their hands.
Leveraging the existing base
Sony has sold more than 2 million VR headsets and that makes it the leader today, driven in large part because it can leverage an existing base of 70 million PS4 consoles, which is essentially the computer that powers Playstation VR. That's a big advantage over Vive and Rift, which require high-end computers and a relatively cumbersome installation process to set up VR.
In some ways, Playstation VR isn't just leveraging the console business that drives about one-fifth of Sony's revenue, it's protecting it from disruption. If gamers transition from consoles to virtual reality, Sony wants to be there to provide the services they're looking for. And if VR indeed grows to be a $28.5 billion business in 2020, it could have a huge impact on Sony's game and network services division, which had $14.7 billion in revenue in fiscal 2017.
While Sony has made VR simple, it's not clear where the company goes from here. Consoles will limit the market opportunity as long as headsets are tethered and when they become untethered, like Oculus Santa Cruz, Sony won't have the same advantage as it has today, unless it builds a new VR platform.
With that caution laid out, there's no question that Sony has an impressive position in the VR market with the largest high-end install base. And that's a reason to be bullish on the company's chances to build a VR giant.
The platform company tries out virtual reality
Alphabet's VR play so far has been on the low end of the market. Cardboard and Daydream are VR headsets that require a separate smartphone and the experience is far inferior to Oculus Rift or HTC Vive.
Where Alphabet has a chance to be a big player is in the platform and advertising space, especially in 360 video. Its YouTube is already a hub for 360 video and applications like Google Expeditions bring VR content to millions of people.
It's less clear how Alphabet would play in the headset market given the low-end products it's made so far and a failed partnership with HTC. But there are only so many tech companies who can build a big VR or 360 video platform and Alphabet is sure to have a seat at the table when it's all said and done.
Virtual reality may be a niche business right now, but if it becomes mainstream and begins to be an important way people communicate, learn, and find entertainment, it'll be important for Alphabet to play a role in the industry. We've already seen Google Earth become a very popular VR application and it's expanding content regularly.
If VR headsets are the next smartphone-type disruption in technology, Alphabet will have myriad opportunities to incorporate its own content and advertising platform to monetize a piece of the industry. VR may be small to a company of Alphabet's size today, but if it reached $28.5 billion in sales in three years or anywhere near the 1 billion people Facebook CEO Mark Zuckerberg estimates it can reach, there's a lot of money to be made in VR for Alphabet.
Don't underestimate VR's future
There may only be a few million high-end VR headsets in people's hands today, and it may be a money-losing business for now, based on more than $3 billion invested by Facebook alone, which is more than the entire industry generates in revenue. But if Zuckerberg is right and 1 billion people end up using VR in the near future, it'll be a multibillion-dollar business worth every cent of investment today. And Facebook, Sony, and Alphabet are three stocks to bet on the future of VR. But with VR being such a small percentage of their businesses I'm not ready to make a call in Motley Fool CAPS based on VR alone, so I'll stay neutral on the stocks on My CAPS page.