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Wearables Are the Next Big Thing: Here's Why Investors Should Be Nervous

By Jamal Carnette, CFA – Feb 12, 2016 at 7:20PM

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Can wearables replace smartphones as a growth driver?

Apple's high-end Watch Edition model. Source: Apple

With the projected slowdown in smartphones, many tech-focused investors are now asking where top-line growth is going to come from. Laptop and desktop computers have been in a state of decline for years and tablets recently reported a 10.1% decline in shipments in 2015 compared to the prior year. With all three devices slowing, investors are left asking what's the next product that can drive revenue higher?

More recently, it seems that next big device could come from the wearable category. Wearable devices like virtual-reality headsets, body-cameras, and fitness monitors are expected to grow shipments 18.4% in 2016 to 275 million devices according to Gartner.

On a revenue basis, Gartner expects wearables to generate $28.7 billion in sales this year -- $11.5 billion of that total will come from smartwatch sales alone. The research and advisory firm estimates smartwatch annual revenue growth of 15% through 2019, reaching $17.5 billion in annual sales that year.

Apple is the driver of increased smartwatch adoption
According to Gartner, look forward to seeing more smartwatches. Gartner expects smartwatch adoption to increase 48% by 2017. According to research director Angela McIntyre, this is due to "Apple (AAPL 1.98%) popularizing wearables as a lifestyle trend." Unfortunately, Gartner's data gave no specifics of smartwatch market share but fellow research firm IDC provides such estimates.

IDC's data seems to confirm Apple is winning the smartwatch battle with a reported 61.3% market share last year versus vendors running Alphabet's Android Wear OS at 15.2%. Going forward IDC expects Android Wear to benefit from its user-base advantage amid increased smartwatch popularity to grow market share a massive 23.6 percentage points to take a 38.8% share in 2019 versus Apple's projected market share of 51.1%.

The biggest loser is device-agnostic smartwatch maker Pebble, whom IDC expects to see its market share drop from 8.6% in 2015 to 2.8% in 2019 as market share consolidates among the major players.

What to do when the next big thing is less big than the current big thing?
In many ways, the smartwatch market is starting to resemble the current "big thing" -- the high-end smartphone market -- with the most visible participants being Apple and Android vendor Samsung (NASDAQOTH: SSNLF). The latter's Gear S2 model is compatible with most Android units allowing it to consolidate market share among Android-powered smartphones -- especially those without a smartwatch offering of their own.

Unfortunately for investors, don't look for smartwatches to be a top-line silver bullet against slowing smartphone sales. The first issue is smartwatch adoption will be limited as the device is simply a companion piece versus a stand-alone gadget like a smartphone. Gartner forecasts nearly 50 million smartwatch sales this year versus smartphone sales in excess of 374 million units.

Secondly, a large product mix transition would hurt the top line as average selling prices, or ASPs, of smartwatches are lower. Last year, a survey from Wristly found the ASP for Apple Watch to be $529; Samsung's Gear S2 retails at $300. Unfortunately, we have to rely on third-party estimates because neither Apple nor Samsung individually report smartwatch results.

As a comparison, Apple produced $51.6 billion in iPhone revenue while reporting $4.4 billion in other products revenue -- the division that Apple reports Apple Watch results in with iPod, Apple TV, and Beats products. Even if Apple captured Gartner's full-year 2019 market projection for smartwatches -- $17.5 billion -- it would be less than the company made in iPhone related revenue any quarter this year. Smartwatches will be value accretive to these tech firms, but it won't be the next big thing for investors.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Jamal Carnette owns shares of Apple. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Apple. 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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