The Internet of Things might seem infinitely complex. Described by many as "a system of systems," there are already estimates that 25 billion devices will be connected by the end of this year.

To help guide investors on how to play this megatrend, Rule Breakers analyst Simon Erickson breaks the Internet of Things down into three layers:

  • "Picks-and-shovels" hardware providers, such as InvenSense (NYSE:INVN) or NXP Semiconductors (NYSE:NXP) provide the backbone of this IOT. These are the sensors, chips, and devices that will collect data from all over the world.
  • Developers will also create software applications for consumer-facing companies to improve the user experience of their products. Under Armour (NYSE:UAA) could help you track your fitness results, or Middleby (NASDAQ:MIDD) could automatically program instructions for its ovens to cook certain dishes.
  • Lastly, infrastructure system providers are responsible for aggregating and interpreting all of this data. Google (NASDAQ:GOOGL)(NASDAQ:GOOG) will emerge as an undisputed winner, but smaller players such as Splunk (NASDAQ:SPLK) will have huge opportunities as well.

Check out Simon's full analysis in the video below — which was filmed on-site at the CES in Las Vegas!

Transcript:

Rex Moore:

Hey, Fools. We are at the 2015 International CES. I'm with Simon Erickson, Motley Fool Rule Breakers analyst, and we are in search of what makes the Internet of Things so great. And Simon, we've got really three ways that investors can look at the Internet of Things — maybe three ways they can play the Internet of Things — and the first one is the hardware layer.

Simon Erickson:

Yes, the hardware layer is really the picks and shovels of the Internet. This is what actually is making the Internet of Things be the things.

Rex Moore:

Okay.

Simon Erickson:

These are sensors. These are chips. These are the things that are actually picking up data, whether it's a movement. Whether it's something that you're touching. This is collecting all the data — the hardware layer — so these are companies on the Rule Breakers scorecard that are actually picking up that data.

We've got GoPro, for example, picking up video data. InvenSense, which is picking up motion and sensing that. And we've got NXP, which is doing near field communications chips so we can actually have communication between devices and stuff like that.

But there's a bunch of other companies, too, that aren't on our scorecard, yet. We just talked to Synaptics [about] fingerprint identification as a hardware play, too. So, picks and shovels. Hardware. Definitely the first layer that investors can play the Internet of Things with.

Rex Moore:

And, of course, you can't run that hardware without software, so that's the second layer, right?

Simon Erickson:

Yes, so the second layer is now you've got all this data. What do you do with this? These are companies that are wanting to develop applications, but already have brands that consumers know and trust. This is your GE Oven. This is something else in your house that has got a device that can now use the Internet of Things as a tool to make your life easier.

And the focus of those companies is really user experience. We want the Internet of Things to be something that's just seamless for users — to free up more time for them to do other things — and just make it almost simple for them to use whatever they've been using before.

Rex Moore:

Good deal. And the final layer we're going to talk about is the infrastructure.

Simon Erickson:

Yes, and then the infrastructure, the highest [layer]. This is like cloud systems. These are systems that aggregate all of this data and all of this software into things that can be interpreted. The most well-known in this category is definitely Google, who's been doing interpretation of data for 20 or 30 years, already, and has got a head start.

But we've also seen a lot of companies rising in this space, too. Splunk is one that we've put on the scorecard recently that was a big one. We also saw a company like Evernote, which is now organizing people's thoughts and data in a cloud-based service.

There's definitely a way to play this Internet of Trends thing not at a hardware level — not at a software level — but even at the data-systems-aggregating level, too.

Rex Moore:

All right, Simon. Great thoughts. Three layers there for investors to play for the Internet of Things. Thanks for joining us.

Simon Erickson:

Sure. Thanks, Rex.

Rex Moore owns shares of Google (A shares), Google (C shares), and Middleby. Simon Erickson owns shares of InvenSense and Splunk. Simon Erickson has the following options: short June 2015 $15 puts on InvenSense. The Motley Fool recommends Google (A shares), Google (C shares), InvenSense, Middleby, Splunk, and Under Armour. The Motley Fool owns shares of Google (A shares), Google (C shares), InvenSense, Middleby, and Under Armour. 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.