Is The Internet of Things a Good Investment?

It’s one of the biggest buzzwords in corporate America today: the "Internet of Things" (IoT). Consumers are constantly hearing about how the network of connected devices – anything that captures and shares data over an IP address – is going to dramatically change the way we operate at home (see 5 ‘Internet of Things’ Products for Your Home), the office (see 5 Ways the Internet of Things Will Change Work ) and how we live in general.

If you’re an investor, the question is whether this trend is really worthy of putting cash into. Could it be that we’re one the precipice of an IoT boom?

The numbers seem to suggest so. There’s a huge untapped market for smart products, from cars that talk to each other to avoid a crash to appliances that only use energy during off-peak hours. The IT research firm Gartner predicts the number of physical objects connected to the Internet will explode from roughly five billion today to 25 billion by the year 2020. 

But actually investing in this trend before it really takes off is easier said than done. While technology-oriented funds abound, those that focus specifically on IoT are hard to find. You can get fairly close with something like the Web X.0 ETF (ARKW) from Ark Investment Management, which identifies companies likely to benefit from game-changing innovations. But the Internet of Things is only one of those innovations; the fund also invests in sectors like cloud computing and social media. 

Currently, the only choice for those who really want to home in on the IoT movement is to invest in individual stocks. Whether that makes sense depends on one’s tolerance for risk.  But if you manage to find a growing company at an attractive price, the upside is certainly there.  

Perhaps the first place for the IoT-minded investor to look are the companies that actually make smart devices. But beware: Some of the more obvious candidates may not represent the best investment opportunities.

For example, Nest Labs, which makes the popular Nest Learning Thermostat, is now owned by Google (GOOG). And given the size of the search giant, it’s unlikely that Nest Labs will have a huge impact in the company’s bottom line, or its stock performance.

Fitbit, Inc. (FIT), maker of the ubiquitous wearable fitness-tracking devices, has performed strongly so far, but it now faces new competitors looking to wrestle away market share (see Is It Time to Invest in Fitbit?). Microsoft, for example, recently launched its own health-oriented wearable device that tracks the user’s heart rate, calorie consumption and sleep quality. And let's not forget the new interactive watch from a certain electronics giant…. 

Less obvious opportunities may be worth a look, then. Take Samsung, whose broad umbrella of devices includes everything from microwave ovens to Blu-ray players. The South Korean company has already been ahead of the curve when it comes to making these products smarter, like developing a washing machine that owners can control remotely. Precisely because of its product breadth, the firm may be uniquely poised to profit from these innovations.

Of course, consumers aren’t the only source of demand for connected devices. Industrial enterprises, eager to cut operating costs and manage their supply chains more efficiently, represent a big market source for IoT. Consequently, device makers that serve the commercial market are worth checking out.

General Electric (GE) is a prime example. The company, which serves the aviation, locomotive and manufacturing sectors (among others) is making a big wager on what it calls the “Industrial Internet.” Reports suggest the company has already pumped $1.5 billion into smart product research since 2012 in the hope of jumping ahead of its rivals. 

GE certainly isn’t the only industrial supplier getting on board, though. Case in point: agriculture giant Monsanto (MON). Its foray into IoT includes the recent purchase of a technology firm that helps farmers better predict the weather. 

The companies that actually market smart devices grab most of the headlines. But the reality is that these companies often rely on third-party firms to help develop and support the products. Consider, for instance, technology firm PTC. By acquiring ThingWorx, a leading software platform for designing and running connected devices, it could be in a good position to benefit from IoT growth.

Then there are the organizations that help make sense of the vast amount of data all those sensors collect. Splunk (SPLK) is one example. The San Francisco-based firm provides software that helps clients collect and interpret the information generated by a multitude of machines across the enterprise. 

Yet another way to take advantage of the IoT trend is by investing in the hardware firms that make IoT possible. That includes everything from chip makers heavily tied to the smart device market, like Qualcomm (QCOM), to networking companies like Ruckus Wireless (RKUS) and Aruba Networks.

There’s a caveat here. In general, hardware is fairly easy to copy (certainly easier than software). So whether companies that have currently make the cutting-edge make processors or supply IoT infrastructure can sustain their success is an open question, as more rivals pop up. Still, the next few years could be rewarding for players – and the people who invest in them – that have plowed these fields early on.  

Investing in the Internet of Things is a hands-on endeavor: Targeting companies truly poised on the edge of the IoT explosion requires a lot of research. But for those who understand the equities market and are willing to stomach some risk (and a long-term view), investing in smart devices could be a smart money move indeed.