At least by my estimation, Internet of Things (IoT) stocks have been a lousy investment. For years, the tech world has been trumpeting the fact that tens of billions of products would get digitized and turned into computing devices -- and it's come true. However, a clear-cut winner in IoT has never truly emerged. 

If you're keeping score, Qualcomm (QCOM -0.01%) has been a great long-term winner with a fast-growing IoT segment, but it's still highly reliant on smartphones. Once upon a time, I also invested in a small company called Sierra Wireless that never really sustained any traction, before finally selling itself to Semtech, which took out significant debt to make the purchase, early in 2023.

But perhaps an industry leader is emerging in Silicon Labs (SLAB 2.44%). Two years ago, Silicon Motion sold its infrastructure and automotive chip business to Skyworks Solutions to transform itself into an IoT pure-play, but then had to endure a brutal bear market in 2022. With the stock showing signs of rebounding, though, is this small IoT investment a good investment as a new era of AI emerges?

Combining hardware with design software

The beauty of Silicon Lab's business is it embraces what has made IoT stocks a poor investment up until this point. It combines all of the many disparate and often competing chip technologies that make internet-connected things possible into one package: Bluetooth connectivity, WiFi, mesh network technology, and inexpensive and readily available microprocessors and sensors. All of these can be packaged into a single (and very small) module.

But Silicon Labs takes it one step further by offering turnkey software solutions to enable its large customer base to quickly and easily design these chips and implement them in the products they're developing. By contrast, many other IoT companies have focused on software that helps manage a network of connected devices, rather than the device design software itself.  

The result is a rich ecosystem of customers designing everything from industrial connected devices (smart HVAC, automated manufacturing equipment, power tools) to commercial building products (smart lighting, security systems, electronic shelf labels) to smart home devices (smart speakers, appliances, climate controls, and sensors).

The result has been tangible growth, even despite an economic slowdown and a chip industry downturn that cropped up late in 2022. 

SLAB Revenue (TTM) Chart

Data by YCharts.

How does AI play into this?

AI, specifically generative AI apps like ChatGPT that run in a data center and that are accessible via the internet, is all the rage right now. This is not a realm that Silicon Labs plays in -- or is it?

You see, eventually the proliferation of new AI services will require some of that computing power be pushed back out to the "network edge," on end devices themselves. Already, Silicon Labs taps compact chip computing power it licenses from ARM Holding, the same company Apple uses to design its own processors for iPhones and MacBooks. PCs and laptops are not a market Silicon Labs participates in, but its myriad of IoT devices could eventually be used to operate AI services too, once they've been trained in a data center somewhere.

Risks, and why the stock is worth watching anyways

Of course, as impressive as Silicon Labs' run has been the last few years, some of the same old flaws with IoT stocks are still a problem. Most notably, the company is barely profitable right now, having generated net income of just $82 million over the last 12-month stretch. Developing lots of affordable IoT devices can generate revenue growth, but it's hard to turn a healthy profit margin when it comes time to sell them. The bear market of 2022 certainly hasn't helped with those efforts.  

Additionally, though IoT as a pure-play has been a tough gig, Silicon Labs cites plenty of competition from big and well-diversified peers like Qualcomm, Broadcom, and others.

Despite these issues, Silicon Labs could still be a promising long-term bet on the IoT and AI. Profitability should rebound in 2024 as economic headwinds from this year are lapped, and if the company can continue its expansion, profit margins could benefit from the company's larger scale. The balance sheet is also in excellent shape with $1.15 billion in cash and short-term investments, offset by debt of just $530 million. Shares trade for 32 times next year's expected earnings.

I'm not quite ready to start nibbling, but all the elements I look for in a small- or mid-cap stock I want to buy are there. Silicon Labs is on my radar.