Of all the up-and-coming industries to watch, the drone market is easily one of the most intriguing. After all, the technology has many applications, ranging from consumer-oriented tasks such commercial package delivery to military-centric missions such as tactical strikes or reconnaissance without putting human pilots in danger.
The Teal Group last year forecast that unmanned aerial vehicle sales will almost double over the next decade, to $11.5 billion annually, including $1.6 billion from civilian customers. But how can investors take advantage of that growth? In my opinion, here are the three best stocks to watch in drones.
1. AeroVironment (NASDAQ:AVAV)
AeroVironment is a rare pure play in the market given its exclusive focus on drones and related technology systems. During last quarter's earnings conference call, CEO Timothy Conver described increased investments in AeroVironment's three largest growth opportunities: tactical missile systems, commercial unmanned aircraft, and the Global Observer program. The first two are fairly straightforward scope, while Global Observer focuses on providing governments an affordable solution for 24/7 surveillance and communications over large areas using high altitude, long endurance, or HALE, drones.
However, as AeroVironment makes these investments with a long-term view, the market has frowned upon the company's resulting top- and bottom-line declines over the near term. In its fiscal third quarter, for example, AeroVironment's revenue fell 1.2% year over year to $68.4 million, while skyrocketing research and development costs were largely responsible for an 80% drop in net income to $2.3 million over the same period. Consequently, AeroVironment stock has fallen nearly 20% over the past year as of this writing.
To be fair, those results were in line with management's expectations, and Aerovironment's funded backlog of orders climbed more than 35% year over year to $89.3 million. But it's hard to blame the market for stepping back until that backlog begins to translate to actual revenue and earnings growth. In the meantime, I think investors are right to watch closely to see if Aerovironment's long-term bets pay off.
2. GoPro (NASDAQ:GPRO)
Action-camera maker GoPro might not seem the most intuitive drone-related stock. But it stands to benefit from the drone market in two key ways. First, there are already a plethora of drones on which users can mount GoPro's HERO cameras to capture high-quality images and video. So it stands to reason that the impending growth in the consumer drone market should also be great news for GoPro's existing hardware sales.
Revenue from camera hardware still comprises nearly all of GoPro's sales. That's why investors were encouraged by a Wall Street Journal report last November that cited "people familiar with its plans" as saying GoPro is developing its own line of consumer drones.
There are many competitors in the space, so this isn't an automatic win. But given GoPro's brand power and existing base of loyal customers, there's no sense in leaving a potentially solid opportunity for incremental revenue on the table.
3. Ambarella (NASDAQ:AMBA)
Finally, you'll have to look under your drone's hood to find Ambarella, which specializes in systems-on-a-chip, or SoCs, for high-definition video and image capture. In fact, Ambarella's SoCs are already used in GoPro's popular cameras, which is great considering GoPro just capped its third consecutive quarter of shipping at least 1 million capture devices. But this also makes Ambarella a shoe-in for a spot in GoPro's upcoming drone line.
GoPro also isn't Ambarella's only win; Drone maker DJI already uses Ambarella's highly power efficient A9 Camera SoC to enable its Inspire 1 and Phantom 2 drones to capture 4K Ultra HD videos at 30 frames per second. During the 2015 Consumer Electronics Show in January, Ambarella introduced its new H1 camera SoC aimed at allowing next-generation action and quadcopter-based cameras to collect 4K UltraHD video at 60 frames per second. Finally, during the fourth-quarter earnings conference call, Ambarella CEO Fermi Wang said the company has been methodical in positioning Ambarella's flying camera solutions as competitively as possible in this young market.
As it stands, that's why Ambarella investors are watching closely for any new design wins in the drone space. If Ambarella can continue grabbing market share this early in the game, it could be poised for considerable growth as the drone industry gains steam.