Apple (AAPL -1.21%) co-founder Steve Wozniak recently warned that the Internet of Thing, or IoT, market could be reaching a "bubble phase" comparable to the dot-com bust in the late 1990s.
Source: Cisco.
Speaking at the World Business Forum in Sydney, Australia, Wozniak said, "I feel it's kind of like a bubble, because there is a pace at which human beings can change the way they do things." He pointed out there were "tons of companies starting up," but that some might have overestimated the appeal of connecting everyday objects to the Internet.
Wozniak isn't the only one who thinks the IoT market might be getting ahead of itself. At Gigaom's Structure Connect event last October, IBM (IBM -0.01%) Vice President of IoT Paul Brody said the market was in "a classic bubble phase," and that most of the data being accumulated on these devices was "useless".
Should investors heed Wozniak and Brody's advice before believing bullish forecasts about the IoT industry?
Irrational industry hype
In the tech world, there's no concrete definition for a "bubble." However, one way to gauge bubble-like growth is through irrational industry hype.
It's easy to find bullish forecasts on the IoT market. Cisco believes the number of connected devices worldwide will double from 25 billion in 2015 to 50 billion in 2020. IDC claims the global IoT market will grow from $1.9 trillion in 2013 to $7.1 trillion by 2020. That's why tech giants such as Google and Apple are pushing into smart homes, connected cars, wearable devices, and mobile payments.
Spotting that trend, start-ups are flooding the market with IoT and wearable devices for even the silliest niches. A fart-analyzing wearable, a sex-tracking wearable, and a smart bra that detects binge eating all indicate developers are getting carried away with connecting things to the Internet.
On start-up tracking site AngelList, the number of IoT-related start-ups surged from 63 in May 2013 to 1,074 as of this writing. Yet only a handful of those companies might produce IoT or wearable devices that appeal to mainstream consumers.
What about valuations?
Another way to spot an industry bubble is to check the valuations of the publicly traded companies in that sector. Three pure-play IoT and wearable stocks to check are Sierra Wireless (SWIR), Skyworks Solutions (SWKS -1.41%), and InvenSense (INVN).
Sierra Wireless is the world's top manufacturer of 2G, 3G, and 4G LTE embedded modules and gateways. Skyworks Solutions produces analog and mixed signal semiconductors for a wide variety of industries. The two companies' products represent the basic conduits between objects and the Internet of Things. InvenSense manufactures motion sensors for the majority of non-Apple smartwatches.
As we can see from their trailing P/S ratios over the past five years, these companies' valuations aren't anywhere near dot-com bubble levels yet:
Source: YCharts.
For example, Cisco's P/S surged to 23 in 2000 right before the dot-com bust. That year, Intel had an average P/S ratio of 11, while Microsoft traded at 17 times sales. Therefore, comparisons between the dot-com bubble and the IoT market might be hyperbolic.
Splitting up the market
The problem with claims that the "IoT bubble" could burst is that they sometimes clump too many categories of products together.
Some markets, such as smart homes and connected cars, could grow at a healthy rate. A recent Coldwell Banker Real Estate survey found that 64% of sales associates believed buyers were more interested in homes with smart features than they were two to five years ago. As for cars, a survey by Accenture found that only 6% of respondents were "not using, nor interested" in using connected navigation systems, and just 14% weren't interested in using infotainment systems for entertainment. Meanwhile, the industrial IoT market -- which helps companies automate tasks and analyze data -- will likely keep growing because it cuts costs and boosts efficiency.
Apple CarPlay. Source: Apple.
As for the wacky market of wearables, a few leaders, such as the Apple Watch, will likely rise to the top while others fade away. Yet many start-ups are still unveiling new wearables products, while angel investors and venture capitalists keep backing them.
A bubble hasn't formed yet...
For a bubble to truly form, mainstream investors must actively prop up the market -- like the way they invested in tech companies during the dot-com bubble. Yet that hasn't really happened yet.
Most of the "hype" comes from the media, crowdfunding sites, and VCs. Publicly traded pure-play IoT and wearable companies aren't trading at huge premiums yet, while larger companies such as IBM and Intel have only recently launched IoT units as long-term investments. The IoT market is certainly growing, but just like any other growing industry, plenty of hopeful start-ups could be crushed along the way.
