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The 7-Point Checklist for Investing in Virtual Reality

Virtual reality has been hailed as the next big thing for the tech industry. Mergers and acquisitions advisory firm Digi-Capital claims that the market could grow to $30 billion by 2020, and Piper Jaffray believes that 500 million VR headsets could be sold by 2025.

Bullish forecasts like those have fueled a land grab for stocks across the VR space in headsets, software, and GPUs. But before you invest in a company based on its claims that VR will boost its sales and earnings, you should run it through this gauntlet of seven simple questions.

Image source: Getty Images.

1. What does the company make?

In the headset market, Facebook (NASDAQ: FB), HTC, Sony (NYSE: SNE), and Samsung are the principal players to watch. Facebook's Oculus Rift and HTC's Vive both target high-end PC gamers; Sony will sell the PlayStation VR as an accessory for the PS4; and Samsung's Gear VR is only compatible with its own flagship phones.

2. Is the product competitively priced?

A major concern about VR headsets is that they're too expensive for mainstream consumers. The Oculus Rift and Vive cost $600 and $800, respectively, and both headsets require "VR-ready" PCs, which generally cost around $1,000.

The PlayStation VR is much cheaper at $400, and a PS4 currently costs $350. Samsung's Gear VR is the cheapest option at $99, but it requires a higher-end Galaxy device, which costs between $400 and $700.

3. How many devices is the company expected to sell?

Piper Jaffray estimates that Samsung will sell 5 million Gear VRs this year, compared to estimated sales of 3.6 million Oculus Rifts, 2.1 million Vives, and 1.4 million PlayStation VRs. Those estimates indicate that cheaper smartphone-based headsets could gain traction faster than pricier PC- and console-based headsets.

4. What percentage of sales will come from VR headsets?

If Piper's estimates are accurate, VR headset sales could generate $2.1 billion in revenue for Facebook this year, compared to $1.7 billion for HTC, $560 million for Sony, and almost $500 million for Samsung.

Looking at that revenue in terms of percentage increase, the impact to HTC would be the greatest, since the Taiwanese smartphone maker only generated $3.8 billion in sales last year. For Facebook, Sony, and Samsung, headset sales would only account for single-digit percentages of their projected sales for the year.

5. How big are their software ecosystems?

Just like gaming consoles, VR headsets are expected to be sold at very thin to break-even margins. Unless headset makers create prisoner-taking software ecosystems, they won't be able to generate high-margin revenue from individual users.

Oculus Home. Image source: Oculus VR.

Back in May, Facebook claimed that its Oculus Home ecosystem -- which is used by Rift and Gear VR headsets -- had over 250 apps. Facebook retains a 30% cut of those paid VR app sales.

Valve, which co-developed the Vive with HTC, currently hosts nearly 200 VR games on Steam, and Sony will launch about 50 VR games for the PlayStation VR later this year. Alphabet's (NASDAQ: GOOG) (NASDAQ: GOOGL) Google also plans to expand its VR ecosystem with Daydream, a cross-platform VR headset tethered to its own VR launcher, later this year.

6. Does that ecosystem have a unique advantage?

Each of these companies has unique advantages. Facebook could eventually connect the Rift to its massive social network. Valve's Steam helps the Vive reach over 125 million gamers worldwide. Sony and Samsung have natural moats since their consoles and phones aren't compatible with other headsets. Google can leverage the strength of the Google Play store to boost the visibility of its Daydream VR apps.

7. Are suppliers better investments?

Another way to invest in the VR market is through GPU suppliers like AMD (NASDAQ: AMD) and Nvidia (NASDAQ: NVDA). Both companies are trying to lower the price of VR-ready PCs with cheaper high-end GPUs. AMD's $200 RX 480 is currently the cheapest VR-ready card, while Nvidia's $250 GTX 1060 comes in a close second. AMD's SoCs also power the PS4 and Xbox One, and new 4K and VR-ready upgrades for both consoles will likely keep using AMD hardware.

Oculus-ready PCs. Image source: Oculus VR.

Sales of AMD and Nvidia GPUs could soar if VR gaming takes off since the market for PC gaming rigs bucked the overall slowdown in the PC market. Therefore, both stocks might be better direct plays on the VR market than less exposed players like Facebook.

The bottom line

There are plenty of ways to invest in the VR market, but investors should understand the unique strengths and weaknesses of each company first.

Facebook dominates most conversations about VR, but the company still generates most of its revenue from ads. The same can be said about Samsung's and HTC's smartphones or Sony's diversified portfolio of media assets, video games, consumer electronics, mobile devices, and imaging products. Investors should learn to cut through the hype to understand the best ways to invest in virtual reality.

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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), Facebook, and Nvidia. 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.