Internet of Things: 3 Up and Coming Stocks to Watch

By Markets Fool.com

The Internet of Things will drive a ton of economic value over the next few years. When everything around you -- from airplane engines and traffic lights to fitness bands and the diabetes sensor in your eye -- is connected to the global Internet, business value almost creates itself.

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But that wealth-creating opportunity is also bringing a plethora of hopeful competitors to battle over the space. Throw an embedded network chip in the air, and it'll land on a new IoT challenger every time. How do you pick long-term winners from a cast of thousands?

Today I'm here to shine the spotlight on three fairly small Internet of Things stocks, with plenty of runway ahead for growth. These companies are carving out their unique niches around the feet of the industry titans. Estimated at $19 trillionin value over the next decade, the IoT pie is definitely large enough to let these minnows grow fat and important from table scraps alone.

We'll start off with motion sensor builder InvenSense , followed by secure computing specialist Red Hat . Rounding out our trio, Pandora Media is building a media service empire on the back of the IoT's universal connectivity.

Let's get started!

Image source: InvenSense.

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Motion sensors everywhere
InvenSense is not for the faint of heart.

The stock comes with a Beta value just above 3.0, which means investments in InvenSense tend to swing about three times faster than the general market -- both up and down. Over the last two years, the share price soared a staggering 160% higher, only to lose nearly half its value in less than three months.

The company has reported earnings 13 times in its young life on the public markets. Seven of these reports missed Wall Street's earnings targets, sometimes by wide margins. InvenSense has delivered just one positive earnings surprise in three years.

Then again, InvenSense is just getting started.

The company ships motion sensors to both Samsung and Apple , to be included in their latest flagship phones. Apple wasn't an InvenSense customer at all in mid-2014, but now accounts for 45% of the company's total sales. Supplying chips to the two largest smartphone makers in the world speaks volumes about InvenSense's product quality.

And smartphones are just the beginning. InvenSense's motion sensors should find their way into a plethora of mobile data collection devices. From health- and fitness-monitoring wristbands and portable video systems to shake-erasing video cameras and industrial manufacturing systems, InvenSense is staring down a wealth of underserved target markets.

As the Internet of Things matures, you'll see rising demand for these motion sensors. They are uniquely positioned to collect important data about the real world, so that larger devices or dedicated server systems can analyze it and reach useful, actionable, valuable decisions. InvenSense is a leader in this promising space, and currently sees only STMicroelectronics as a serious rival.

The stock can give you a bumpy ride, but it currently trades on the cheaper side of its wild price swings. Fellow Fool Adam Levy expects strong revenue growth this year, coupled with a good chance of profit margin expansion. If that scenario plays out as Adam suggests, InvenSense shares are likely to take another upward leap before the year is over.

If not, the booming Internet of Things trend should still support InvenSense's value in the long run. With its premium client list and an enterprise value of just $1.4 billion, this small-cap business could even become a buyout target.

Image source: Red Hat.

This IoT ninja wears a red fedora
Every gadget, contraption, and gizmo on the Internet of Things needs to run a little bit of software. If nothing else, the device needs to connect to a server somewhere, in order to deliver its carefully collected real-world data for further analysis.

That opens a world of opportunity for operating system specialists. And it's even better if your systems are known for a combination of high security and easily managed software updates, maybe even alongside low licensing fees and affordable costs of ownership.

Linux veteran Red Hat delivers all of the above. The company became a favorite Internet of Things systems supplier by popular demand.

Its regular customers saw a perfect fit between Red Hat's secure data services and the requirements of a widely distributed network design. It doesn't hurt that Red Hat also provides easy-to-use data messaging technologies.

Today, the Internet of Things is baked into pretty much everything Red Hat does. "There's no SKU that you order to buy '10 Internet of Things things,'" said Red Hat executive Paul Cormier when the company crushed fourth-quarter expectations. "Instead, it's a usage pattern applied to many of our products. A lot of the deals that we saw this quarter can be categorized as that, where it's not just about the operating system anymore."

The IoT is an invisible hand lifting Red Hat's overall results, higher and faster than the core Linux operation could deliver on its own. Red Hat was smart to jump on the multilayered Internet of Things market early on, and is likely to ride the growth wave for years to come.

"We don't report an Internet of Things product, but indirectly, that's a big contributor to our whole product portfolio getting more robust," Cormier explained.

Red Hat shows that the Internet of Things can propel solid business results without drawing much attention to itself. If InvenSense was an obvious IoT pick, then this stock is a fairly stealthy play on the same phenomenon. I'm invested in Red Hat myself.

Image source: Pandora.

Pandora in every box
Let's take the stealth approach just one step further. Hello, Pandora Media -- potential Internet of Things investment extraordinaire.

I don't expect Pandora to build or manage millions of media-streaming devices. Instead, I expect the company to keep developing Pandora-playing apps for every new platform that emerges. This way, users can get their Pandora fix on any device they desire.

Think I'm kidding? Think again. Pandora has already reached far beyond the expected Android and Apple markets to create custom media apps for a mind-boggling range of convenient devices.

Your next TV set is likely to come with built-in Pandora support. So will your next car. The company offers a program for businesses that want to play properly licensed music streams in a commercial setting. Did you know that Windows Phone has a Pandora app available today? How about BlackBerry-- the black sheep of the mobile world?

Yessir, it's all there. And the portfolio of supported devices will only continue to grow.

The company doesn't mind spending the effort to bring its services to downright unpopular platforms like BlackBerry. It's all about building mind share right now, setting Pandora apart from a rising tide of competitors. Truth be told, the streaming entertainment market is large and flexible enough to let a plethora of rivals divide the space between them.

And, of course, the streaming media sector will continue to expand as long as hardware designers keep coming up with new devices on which to consume music, movies, e-books, and other media. So Pandora is attached to the Internet of Things much tighter than you might think.

If you build it, Pandora will make an app for it. And then the consumers will come. That's the long-term plan, anyhow.

The article Internet of Things: 3 Up and Coming Stocks to Watch originally appeared on Fool.com.

Anders Bylund owns shares of Red Hat. The Motley Fool recommends Apple, InvenSense, and Pandora Media. The Motley Fool also owns shares of Apple, InvenSense, and Pandora Media. 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.