1 Top Wearables Stock to Buy Now

There's no denying that wearables is a major, fast-growing trend in tech. Research company IDC estimates that the overall wearables market will swell from about 113 million shipments in 2017 to 222 million shipments in 2021 -- nearly doubling in just four years.

But this doesn't make stock picking in this segment easy. Even though it's clear that this billowing market is here to stay, not every stock involved in wearables is a buy. Indeed, one of the purest bets on activity-tracker devices -- Fitbit -- has proven to be a horrible investment.

If you're looking for a company to invest in that sells wearable technology, like tracker wristbands, smartwatches, smart earbuds, or simply the software behind wearable tech, here's one that actually looks poised to perform well: Apple.

Apple Watch. Image source: Apple.

But before we dive into what makes Apple such a good bet on wearables, here's a brief overview of a few of the top companies in the segment.

Wearables stocks: An overview

Data source: Reuters.

Much smaller than Apple, Fitbit and Garmin are, not surprisingly, purer bets on wearables than the tech juggernaut. But if there's one thing investors can learn from Fitbit's unfortunate decline from an initial public offering of $20 in 2015 to a stock price of about $5 today, it's that in this highly competitive market, size has its advantages.

The wearable devices Fitbit has specialized in since its IPO -- basic activity-tracker wristbands -- are "quickly becoming commodities," IDC said in its recent report on the wearables market. Replacing them in popularity are smartwatches. But smartwatches are more complex devices, with lower profit margins, requiring more up-front investment in software, technology, and manufacturing -- efforts a tech giant like Apple is well equipped for.

Fitbit's struggle as it transitions to a product line more heavily weighted in smartwatches is apparent in the company's narrowing gross profit margin. Fitbit sported a gross profit margin of 48% in 2014, just before Apple launched the Apple Watch in early 2015. Its trailing-12-month gross profit margin, however, was just 35%.

Due to the narrowing gross profit margin and rapidly rising research and development costs, Fitbit's annual net income has fallen from $132 million in 2014 to a loss of about $400 million in the trailing 12 months. As the company turns to smartwatches in hopes of distancing itself from the increasingly commoditized activity-tracker wristband market, its profitability has plummeted.

Garmin, by contrast, has found a way to fight off heightened competition in wearables by doubling down on niche markets, catering to specific athletes, namely runners, bikers, and swimmers. But after watching Fitbit struggle as badly as it did over the past few years, I'd rather place my bet in this ruthless segment on a tech giant than a niche player -- even if Garmin has proven it can hold its own.

Apple Watch, AirPods, and beyond

There's a lot to like about Apple's bet on wearables. Beyond Apple's sheer size and the virtually unlimited resources at its disposal for product development, software, manufacturing, and marketing for its wearables products, the company's performance in wearables has simply been downright impressive.

Here's a fact that might surprise you: The second-largest contributor to Apple's year-over-year revenue growth for its record first fiscal quarter wasn't iPad or Mac. It was wearables, Apple CFO Luca Maestri said in the company's fiscal first-quarter earnings call. Including sales from Beats, AirPods, and Apple Watch, wearables revenue was up 70% year over year during the quarter. And strong growth in wearables wasn't isolated to the holiday quarter. Revenue from wearables was up 75% in Apple's fiscal 2017. 

Apple Watch -- Apple's most important wearables product -- has seen significant momentum recently. The fiscal first quarter of 2018 was the best quarter ever for the smartwatch, marking the fourth quarter in a row the product saw 50% year-over-year growth in both revenue and units sold. Apple Watch also saw "strong double-digit growth in every geographic segment," Maestri noted during the quarter's conference call.

Image source: Apple.

Notably, Apple may have just tapped into the next big catalyst for wearables: LTE technology. In its first-quarter conference call, management said the new Apple Watch Series 3, which offers an option for an LTE connection, saw sales that were double the volume of its Series 2 watch in the year-ago holiday period. Perhaps LTE connectivity for wearable devices could help Apple sustain its uncanny growth rates in wearables even longer.

Apple doesn't break out its wearables sales, but the broader "other products" segment that they fall into has consistently been the company's fastest-growing segment lately. This trend was particularly strong in the fourth quarter of fiscal 2017 and the first quarter of fiscal 2018. In both periods, revenue in the segment soared 36% year over year.

Sure, Apple's other products segment only accounts for about 6% of total revenue, but when considering secular tailwinds in the overall wearables market and Apple's success so far with the Apple Watch and AirPods, wearables will likely only grow in importance to Apple.

Of course, there's also the possibility that Apple launches entirely new wearable products with similar growth potential -- something Apple has the financial resources for.

The risks

It's possible that even Apple could make a misstep in this fast-growing market. Even though the tech giant has a long history of successfully bringing new products to market, it's worth noting that its wearables lineup is far more concentrated than Fitbit's and Garmin's. This means that if Apple brings to market a flop in wearables, it could have an outsize negative impact on the nascent category.

In addition, though Apple's wearables business currently looks poised to grow quickly, worse-than-expected performance in other larger segments could suppress the stock's potential, or even cause it to decline. The iPhone, for instance, accounted for 62% of Apple's trailing-12-month revenue, putting the stock at risk if the product segment's revenue growth comes to a halt or -- worse -- declines.

But even after considering these risks, Apple's overall value stands out, helped by its fairly conservative valuation, healthy trailing-12-month growth across all of its product segments, and strong growth potential in services -- another fast-growing Apple product segment.