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Our Favorite Internet-of-Things Stocks for 2016

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A huge opportunity is coming, and a few major players (and a smaller one) are well poised to take advantage of it.

"Internet of Things" has become one of those terms that people hear all the time while not always understanding exactly what it means. 

Essentially, the IoT is the world of connected devices. In layman's terms, it's when you take something that's normally "dumb" -- be it a table, a toaster, or pretty much anything else -- and make it "smart" by adding connectivity, as well as some basic computing power. The IoT can be a refrigerator that emails you when you run out of milk or an MRI machine that schedules its own maintenance. Really, the potential is limitless, which is why so many tech companies want to be a part of it.

Worldwide spending on IoT will grow at a 17% compound annual growth rate, from $698.6 billion in 2015 to nearly $1.3 trillion in 2019, according to the most recent International Data Corporation Spending Guide. If those numbers pan out, a huge new category is being created. But we're still in the early stages of what will be a fast-moving technological revolution.

A number of companies are well positioned to take advantage of the opportunities created. Here's a look at four our panel of Fools think are worth investing in this year.

Jamal Carnette, Verizon (VZ -2.34%) and AT&T (T -2.12%): Many times investors miss the forest for the trees, and that's no different in the Internet of Things. While many are focused on new, untested companies with high risk and return potential, I'll be watching proverbal "pick and shovel" plays AT&T's and Verizon's moves in the space closely.

It's safe to assume the automobile will play a major role in the IoT opportunity -- Gartner predicts a quarter-billion Internet-connected cars will be on the road by 2020. Recently, AT&T reported a partnership with the Ford Motor Company to (NYSE: F) power more than 10 million vehicles equipped with Ford's SYNC technology by 2020. This deal continues AT&T's IoT strategy, as the company signed more than 300 IoT business agreements last year. It's safe to say telecoms are going to play a major role in shaping delivery to IoT-enabled devices.

However, AT&T hasn't given provided investors with specific numbers regarding IoT monetization. Verizon has, and it reported nearly $700 million in IoT-related revenue last year. Even better for investors, these companies appear to not have IoT growth baked into the valuations. Both AT&T and Verizon trade at a forward price-to-earnings ratio of 12.5 times.

If the Internet of Things is as big as many envision, the boost to both revenue and profit could be big enough to more than offset any weakness in their core wireless businesses. And even if it's not huge, you still own two relatively inexpensive companies with above-average dividend yields.

Daniel B. Kline, Microsoft (MSFT -0.97%): As my colleague pointed out it, won't just be risky start-ups that profit off the IoT. Established companies should also be able to move into this emerging area, and Microsoft has positioned itself well to earn some new business for its Windows 10 operating system.
Smart devices aren't full-powered computers, but they still need an OS to provide whatever limited functionality they offer. There is not an agreed-upon standard for what the system should be, but Microsoft has engineered Windows 10 to power IoT devices. That will make it very attractive especially for high-end business applications, because the computers being used in enterprise generally run Windows. That makes using the OS as the brain behind connected devices simply a logical extension of what companies are already doing. 

One developer team used Windows IoT Core to create a connected clock radio. Source: Microsoft.

Microsoft has already gotten ahead of the Internet of Things curve by releasing Windows 10 IoT Core, a version of Windows 10 optimized for smaller devices with or without a display that runs on the Raspberry Pi 2, Arrow DragonBoard 410c & MinnowBoard MAX. "Windows 10 IoT Core utilizes the rich, extensible Universal Windows Platform API for building great solutions," according to a company Web page.
This product allows developers to begin creating uses for Windows on connected devices. It should also create a pool of programming talent ready to use Windows to power IoT devices.
Microsoft is essentially seeding and watering now so its garden will grow in the years to come. It's a smart strategy built upon the pure logic that companies will want Windows IoT devices because they already use WIndows computers.
Anders Bylund, NXP Semiconductors: It's one thing to make a halfhearted attempt at breaking into a hypergrowth market like the Internet of Things. Betting the farm on this new opportunity? That's what NXP Semiconductors (NXPI -1.40%) is doing, and that's taking the IoT bet to the next level.

In case you didn't notice, NXP recently closed a blockbuster $11.8 billion merger with Freescale Semiconductor. That was not one large company picking up a smaller operation, easily plugged into some gaping business hole. It was a merger of equals, taking two respectable chip builders and combining them into a single giant.

Source: NXP Semiconductors.

Before this deal, you probably knew NXP as the maker of the NFC chips required to make payments at the cash register with your trusty phone. Besides that unique market, NXP rested on a bed of industry-standard data security and connectivity processors. A solid enough business model, mind you, but not one steeped in fantastic growth.

Freescale changed all that.

Together, NXP and Freescale instantly became the largest vendor of automotive semiconductors in the world. This company is now the gold standard for in-car processing, against which all other players must measure themselves. And automotive computing, security, and connectivity will be one of the largest sub-sectors inside that Internet of Things blob. Certainly, it's probably the one IoT market you'll personally notice the most.

I haven't even touched on the economies of scale that come with this bold combination, or how dominating the in-car market can build a pathway into other sectors. No matter.

At least I got you to start thinking about the hardware in those hyper-connected gadgets. The new NXP will be found in lots and lots of them.

Anders Bylund has no position in any stocks mentioned. Daniel Kline owns shares of Microsoft. Jamal Carnette owns shares of AT&T. The Motley Fool owns shares of and recommends Ford and NXP Semiconductors. The Motley Fool recommends Gartner and Verizon Communications. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Stocks Mentioned

AT&T Inc. Stock Quote
AT&T Inc.
$15.32 (-2.12%) $0.33
Microsoft Corporation Stock Quote
Microsoft Corporation
$246.79 (-0.97%) $-2.41
NXP Semiconductors N.V. Stock Quote
NXP Semiconductors N.V.
$158.99 (-1.40%) $-2.25
Verizon Communications Inc. Stock Quote
Verizon Communications Inc.
$37.84 (-2.34%) $0.91
Gartner, Inc. Stock Quote
Gartner, Inc.
$300.76 (0.33%) $0.98

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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