Is A Stock Market Bubble Brewing in "Internet of Things" Stocks?

By Markets Fool.com

The Internet of Things (IoT), the idea that everyday deviceswill be connected to one another, is one of the hottest topics in tech today.

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Market forecasts for the IoT market are accordingly bullish. Cisco estimates that the number of connected devices worldwide will double from 25 billion in 2015 to 50 billion in 2020. Research firm IDC forecasts that the entire IoT market will grow from $1.9 trillion in 2013 to $7.1 trillion by2020.

Is a bubble forming?
Yet there are naysayers who claim that those figures are grossly exaggerated. Paul Brody, the Internet of Things VP at IBM , claimed that the IoT market was in "a classic bubble phase" at Gigaom's Structure Connect event last October.

Brody's statement was aimed at the horde of start-ups promoting "half-baked" solutions for connecting everyday objects, like coffee makers and toasters, to the Internet. Brody declared the data stored by such start-ups was basically "useless." Instead, Brody believes that the IoT market "will grow one very compelling use case at a time."

Should investors heed Brody's warning? Let's examine the valuations and growth rates of the top players in the IoT market, and see if they hintat the formation of a potential bubble.

What do the valuations tell us?
Since many IoT efforts are tucked away within larger companies, we should first check in on "pure play" IoT stocks to gauge investor interest. Two such stocks are Sierra Wireless and Skyworks Solutions .

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Sierra Wireless is the world's largest manufacturer of 2G, 3G, and 4G LTE embedded modules and gateways for machine-to-machine (M2M) communications. Skyworks Solutions manufactures analog and mixed signal semiconductors for a wide variety of mobile, industrial, medical, military, automotive, energy infrastructure, and network uses. Both companies' products are essential conduits between everyday devices and the Internet of Things.

Source: Sierra Wireless.

Thanks to rising interest in the IoT market, both stocks have soared. Sierra is up 70% over the past 12 months and Skyworks has rallied 160%. To gauge whether or not that has sent them into "bubble" territory, let's compare their basic fundamentals to the S&P 500.

P/E ratio

P/S ratio

P/B ratio

Sierra Wireless

N/A*

2.2

3.3

Skyworks Solutions

32.7

6.9

6.7

S&P 500

20.5

1.8

2.9

Source: Yahoo Finance, April 21. *Sierra Wireless posted a GAAP loss last quarter.

Both Sierra and Skyworks are trading at a premium to the market, although they arguably deserve to do so since they are growing at a faster rate. Sierra Wireless lacks publicly traded "pure play" competitors in the M2M module market, which makes "fair" valuations tough to calculate. Skyworks mainly competes against other semiconductor/IC companies, which have an average P/E of 34 and P/S of 2.6. That makes Skyworks cheaper on a bottom line basis but pricier based on sales.

Nonetheless, neither Sierra and Skyworks are trading anywhere near "dot-com bubble" valuations yet. By comparison, Cisco -- which trades at 17 times earnings and 3 times sales today -- had a P/E ratio of170 and a P/S ratio of 29 prior to the dot-com bust at the beginning of 2000.

What about larger companies?
Meanwhile, larger companies are establishing dedicated IoT divisions. Intel , for example, established an IoT division in late 2013. That division houses the tiny Quark processor, the SD-sized computer Edison, and Curie, a button-sized IoT module.

In 2014, Intel's IoT revenue rose 19% year-over-year to $2.1 billion as operating income climbed 12% to $616 million. On its own, the division generates nearly as much revenue as Skyworks' entire business and almost four times as much annual revenue as Sierra Wireless. Intel and Qualcomm have also formed competing IoT alliances for IoT communication standards.

In early April, IBM also formed a new IoT division, pledging to invest $3 billion to $4 billion on the business over the next four years. That move, which partially contradicts Brody's earlier statement about an IoT bubble, is an encouraging sign for the industry. Networking giant Cisco has also invested $1 billionin IoT products and solutions, and plans to invest another $1 billion in the industry by 2017.

The bubble hasn't formed ... yet
Looking ahead, IoT players might have a tough time establishing a full presence in consumer-facing smart home products. As a result, many start-ups expecting consumers to line up for cloud-connected smart appliances could fail. However, the growth of the Industrial Internet, also known as the IoT for large machinery, could support that growth until smart home solutions gain mainstream acceptance.

IoT "conduit" stocks like Sierra Wireless and Skyworks Solutions certainly aren't cheap, but they're nowhere near dot-com bust valuations yet. There's certainly a lot of hype about the Internet of Things, but themarket is supported from multiple fronts by heavyweight companies like Intel, Qualcomm, and IBM. Therefore, tech investors shouldn't worry about an IoT bubble forming and bursting anytime soon.

The article Is A Stock Market Bubble Brewing in "Internet of Things" Stocks? originally appeared on Fool.com.

Leo Sun has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems, Google (A shares), Google (C shares), Intel, and Sierra Wireless. The Motley Fool owns shares of Google (A shares), Google (C shares), International Business Machines, Qualcomm, and Skyworks Solutions. 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.