Pull over George Jetson!  Self-parking cars, self-dimming mirrors, collision warning signals and voice responsive infotainment are no longer features of futuristic pods. Walk onto the floor of any car showroom and you will be bombarded with electronic bells and whistles.  Heated seats and electronic side mirrors, once considered pampered choices are now standard options.  Voice activated calling and cars that beep when you slip into another lane are here to greet you.  The market potential for Smart Cars is large and growing bigger every day.

A revolution is taking place in our four wheeled homes.  Draconian advances in the speed and intelligence inhabiting ever shrinking chips have helped fuel this sea change. Tiny chips are replacing metal widgets to replicate their function with improved efficiency and lower weight. LMC Automotive notes that as many as 80 to 100 microcontrollers are included in every car to support advanced features. Recent regulatory changes by the National Highway Traffic and Safety Administration will supply another wave of demand to fuel the geometric growth in this industry.

Industry experts predict dollars spent on Smart Car technology will swell from current levels of $29 billion to $105 billion over the next five years.  This represents a 29% compound growth rate, a rate well above most industrial markets. Read on to find out who the benefactors of this technology tsunami are.

Spending on Smart Car technology can be fragmented by function and then split between hardware and software.  The major buckets of spending can be broken down into the following categories- Advanced Driver Assistance Systems (ADAS), Infotainment Systems, Engine and Energy Management and Advanced Motor Control.

But it is a long bumpy road to become a supplier in the automotive industry.  The barriers to entry regarding safety and reliability for automobiles are significant. While a fail rate of five percent may be acceptable for the consumer electronics that many of these companies help produce, that rate falls to zero for a motorized vehicle.  Buying stocks of companies who already have been approved as suppliers is mandatory.

Advanced Driver Assistance Systems (ADAS) are a well established feature in many cars.  Embedded cameras tied to sophisticated software provide drivers with information about where their car is in space.  They provide auditory signals, like the warning beep received when your car gets dangerously close to a pole, as well as visual signals like the worrisome red stripe that blankets the image of your rear bumper as you attempt to squeeze your Honda Pilot into a parking space fit for a Mini-Cooper.  These systems include lane departure warnings, adaptive cruise control and self-parking capabilities.

Just recently the National Highway Traffic and Safety Administration and the Insurance Institute for Highway Safety reached an agreement with the top ten leading U.S. automakers to include collision avoidance systems as a standard feature in upcoming models.  Mobileye (MBLY) makes software that helps control many ADAS features and will benefit from this regulation.  STMicoelectronics N.V. (STM) makes the proprietary EyeQ chips used in Mobileye’s product and Nvidia’s (NVDA) Tegra processors help process signals received.

Infotainment Systems are coveted by most drivers.  Road trips, long the bastion of ennui, are now a blank canvas for entertainment.  While tots in the back seat happily consume an endless loop of Disney’s Frozen, adults in the front juggle emails, Spotify and voice activated texts. Smart phones are integrated with infotainment systems so that contacts and playlists seamlessly display on the dash.  Harman (HAR) has been the primary beneficiary from this trend. Chips from Nvidia and NXP Semiconductors N.V. (NXPI) are also used to power these systems.

Engine and Energy Management features are less showy but imperative to improving functionality.  While a well charged car battery doesn’t get much appreciation from drivers, auto manufacturers are investing an inordinate amount of money and time to improve battery life. The batteries of popular hybrid and electric cars require increased energy efficiency that chips can help produce. In order to avoid warranty expenses auto manufacturers want to take every possible step to ensure that batteries survive until the end of their warranty period. Sensors from companies like German based ZMDI and microprocessors made by Freescale Semiconductor (FSL) help rev up or slow down an engine so that just enough power is used at all times.

Advanced Motor Control features are probably the least sexy electrical component to smart cars but the most difficult to gain approval for.  These under the hood chips and sensors measure things like brake pressure to determine the health of your brake pads.  Other motor-control systems calibrate pumps, fans, compressors and rotators- the unsung heroes of our cars’ backbones. Infineon and ZMDI make chips that help monitor and regulate these functions. Integrated Device Technology (IDTI) recently acquired ZMDI winning it a coveted spot as an automobile supplier.  

While many of the companies mentioned here are public, being on the right side of the demand wave is only part of the fuel that drives a stock higher.  Stocks trading at PEs less than or equal to their expected growth rates typically present a better value.  In addition sleuth analysts must explore a company’s balance sheet and cash flow statement to assess its overall financial health.

Of the stocks noted above Nvidia, Mobileye and Integrated Device Technology look most attractive to us.  All of them trade with PEs below their growth rates, generate robust cash flow and are not burdened by excessive debt.  If we had to pick one favorite it would be IDTI as analysts’ estimates are just catching up to account for its ZMDI purchase.  

As the prevalence of Smart Car applications proliferates and deepens, many stocks will be lifted by the ballooning demand.  Buying stocks at reasonable PEs reduces the risk of air pockets, shocking drops in a stock price instigated by missed estimates. In a sector where the ground is shifting so dramatically, attention to valuation and financial health is critical. Despite the temptation to jump into the fast lane, investors should gain significant mileage buying these slow and steady stocks.