Wearables Stocks: What to Watch in 2017

By Markets Fool.com

Two years ago, Wall Street and Silicon Valley thought wearables would be the "next big thing." But as Peter Lynch warned inOne Up on Wall Street, "the next of something never is -- on Broadway, the best-seller list, the National Basketball Association, or Wall Street."

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Much of that enthusiasm was fueled by the launch of the Apple (NASDAQ: AAPL) Watch. In a wildly bullish prediction, Morgan Stanley's Katy Huberty claimed thatApple could sell 60 million Apple Watches within the first year. Apple actually only sold about 12 million watches in2015, and shipments declined annually this year due to competition from rival smartwatches and fitness trackers.

Apple Watch. Image source: Apple.

Shares of Fitbit (NYSE: FIT), the biggest wearable maker in the world, surged from an IPO price of $20 to almost $50 before plummeting to around $8 on concerns about slowing sales, rising expenses, and market commoditization. Alphabet's (NASDAQ: GOOG) (NASDAQ: GOOGL) Google Glass, which was expected to usher in an era of smart eyewear, flopped due to privacy concerns,and was discontinued last January.

The wearables market certainly disappointed some overeager companies during the past two years, but will the fledgling market fare better next year? Let's examine the key trends which will impact the market in 2017.

The evolving smartwatch market

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Smartwatch shipments fell 51.6% annually during thethird quarter of 2016according to IDC. Apple's shipments dropped 71.6% to just 1.1 million shipments, marking the worst year-over-year decline of the top three vendors.

Garmin's (NASDAQ: GRMN) shipments surged 324.2% annually to 600,000 units, making it the second biggest smartwatch maker after Apple. That growth was fueled by the strength of its Connect IQ-enabled watches, the high-end Fenix Chronos, and GPS-enabled devices focused on health and fitness.

Garmin's Fenix Chronos. Image source: Garmin.

Samsung, which dropped to third place, grew its shipments by 9% to 400,000 on the niche appeal of its Gear S2 watches, which feature stand-alone cellular connectivity. In 2017, investors should see if Apple can maintain its lead in the smartwatch market as other iOS-compatible devices take aim at the Apple Watch.

The growth of the sports performance market

Garmin's growth made it the fourth largest overall wearables (fitness trackers plus smartwatches) maker in the world after Fitbit, Xiaomi, and Apple -- in that order. However, Garmin and Fitbit are each trying to carve out a niche in the "sports performance" market to widen their moats against low-end fitness tracker makers like Xiaomi and high-end smartwatch makers like Apple.

Between the second quarters of 2015 and 2016, Garmin's total wearable shipments surged 106.7% to 1.6 million, but Fitbit's only rose 28.7% to 5.7 million. Garmin sells a wide range of dedicated wearables for specific activities, like swimming, golfing, and jogging. Encouraging developers to create apps for its Connect IQ app store has also added new functions to its wearables. Fitbit, however, offers a smaller selection of wearables which are aimed at the general health and fitness market.

The commoditization of the low-end fitness tracker market

Fitbit now generates most of its revenue fromthe higher-end Blaze, Alta, and Charge. That's likely because it realizes that the market for lower-end fitness trackers is being commoditized quickly by cheap devices like Xiaomi's $15 Mi Band.

Xiaomi's Mi Band. Image source: Xiaomi.

Fitbit still generates significant revenue from its $100 Flex 2, but the device will likely lose ground to cheaper rivals next year unless its corporate wellness programs take off and boost bulk orders.

That's why it's crucial for Fitbit, Garmin, and other wearables to carve out their own "sports performance" niches. Otherwise, they would likely be crushed between cheaper smartwatches and fitness trackers.

Expanding beyond the wrist

IDC predicts that total wearable shipments -- which includes fitness trackers, smartwatches, smart eyewear, and clothes -- will hit 213.6 million by2020. IDC expects most of those shipments to consist of watches and wristbands, but smart eyewear and clothing could gain traction next year as consumers grow accustomed to wearing connected devices.

Snap's Spectacles, for example, have already gained more mainstream monentumthan Google Glass. If those smart glasses gain more steam, we could see competing devices with integrated social media functions enter the market. Connected clothing remains a tiny niche market, but Under Armour, Samsung, Google, and other companies have allbeen testing out various types of connected clothing.

Mainstream interest and adoption

Looking ahead, the biggest hurdle will be generating enough mainstream interest in wearable devices. Many smartphone owners don't see the point of buying a full-featured smartwatch for displaying notifications or running mini-versions of their favorite apps.

Many newer smartphone chipsets also track steps and heart rate (via the camera sensor) just as accurately as basic fitness trackers. High prices and privacy concerns could also discourage consumers from connecting their wardrobes to the cloud. Therefore, investors should exercise caution with companies invested too heavily in wearables -- the market is still evolving, and its long-term growth still faces plenty of hurdles ahead.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Leo Sun has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Apple, Fitbit, and Under Armour (A Shares). The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. 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.