Forget STMicroelectronics -- Himax is a Better Augmented Reality Stock

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The market for augmented reality (AR) devices, which project digital objects onto real world surfaces, could generate a lot of revenue over the next few years. Tech M&A advisory firm Digi-Capital claims that the fledgling market could become an $83 billion one by 2021.

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Bullish estimates like that sent many investors scrambling for AR-related investments, and chipmaker STMicroelectronics (NYSE: STM) is often mentioned as a potential AR play thanks to its production of motion sensors and computer vision chips. While STMicro is a decent investment, I think that investors looking for a more aggressive play on the AR market should consider Taiwanese chipmaker Himax Technologies (NASDAQ: HIMX) instead.

What does Himax do?

Himax mainly sells display driver ICs (integrated circuits) for smartphones, tablets, and monitors. Sales of those components accounted for 80% of its top line last quarter, but demand is highly cyclical. To diversify its business away from those components, Himax developed non-driver components for AR, VR, and 3D-sensing technologies, which generated the remaining 20% of its revenues last quarter.

During that quarter, both the display driver and non-display driver businesses posted double-digit annual revenue declines, causing Himax's total revenues to fall 25%. But looking ahead, cyclical demand for those products should accelerate during the second half of this year and next year.

Why is Himax considered an AR play?

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Himax gained a lot of attention four years ago when Alphabet's (NASDAQ: GOOG) (NASDAQ: GOOGL) Google used its LCOS (liquid crystal on silicon) products in Google Glass. Google also acquired a 6% stake in Himax, which seemingly indicated that its LCOS and WLO (wafer-level optics) components could be widely used for AR applications.

Unfortunately, the original Google Glass flopped due to its high price, awkward appearance, and privacy concerns. However, Google recently reintroduced a new version of Glass as an enterprise device, which could fare much better than the original consumer-facing version.

Himax also reportedly supplies core LCOS and WLO components for Microsoft's (NASDAQ: MSFT) HoloLens AR headset, which hasn't been commercially launched yet. When it launches it could become an integral part of the Windows 10 ecosystem, which will soon be updated for AR images with its Creators Update.

Himax is also expected to supply 3D-sensing components for the camera in Apple's (NASDAQ: AAPL) upcoming iPhone X. That depth-sensing camera will likely be used to power next-gen AR applications, and might even tether the iPhone to a HoloLens-like headset. All these tailwinds could significantly boost the growth of Himax's non-driver business -- if those optimistic AR estimates don't miss the mark.

Why is Himax a better AR play than STMicro?

STMicro makes motion sensors (like gyroscopes and accelerometers), and it manufactures computer vision chips for Intel's Mobileye, which sells crash avoidance systems to major automakers.

Many of STMicro's components are used in AR and VR devices projects like Google's Daydream and Project Tango -- which was recently replaced by its ARCore initiative. However, STMicro actually generates most of its revenue from automotive chips, followed by its microcontroller and digital ICs group and its Analog and MEMS group.

That last group, which generated just 25% of STMicro's revenues last quarter, houses the motion sensor business, which is mainly focused on the mobile, industrial, and scientific markets. While some of those motion sensors are used in AR devices, STMicro's components aren't exactly unique. Rivals like Bosch -- which reportedly supplies Apple with motion sensors in the iPhone 8 -- produce similar components.

Himax, however, is considered the "best in breed" producer of LCOS and WLO components, making it the go-to supplier for tech giants like Google and Microsoft. So if demand for AR hardware abruptly surges, Himax should receive a much bigger boost than STMicro.

But mind the pitfalls

Himax is a more direct AR play than STMicro, but its stock isn't cheap at 81 times trailing earnings and 48 times forward earnings -- which are very high relative to the industry average P/E of 24 for semiconductor companies. STMicro's trailing P/E of 44 also looks lofty, but its forward P/E of 17 looks fairly reasonable.

I'm personally not sold on the notion that AR will become a mainstream technology in the near future yet. It could be great for certain enterprise uses if the hardware isn't too expensive, but we could still be years away from mainstream consumers wearing smart glasses and heavily using depth-sensing AR apps. Therefore, I still consider Himax a speculative play which relies a bit too much on bold forecasts about the AR market.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Leo Sun has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Apple. The Motley Fool has a disclosure policy.