Augmented reality will drive the next wave of smartphones — and Apple is destroying its competition (AAPL)

Tim Cook

"We view AR as a revolutionary technology trend."

That's the opening line of a big report out from Katy Huberty, an analyst at Morgan Stanley, on the state of augmented reality and its impact on global markets. The biggest effect is likely to come to the smartphone business, Huberty said.

"We see a bull case of AR adding $404B to our smartphone device and services revenue forecasts over the next three years," Huberty said. That's $134.67 billion if split evenly between the three years. For perspective, Apple sold about $136.7 billion worth of iPhones in 2016, according to data from Bloomberg.

Huberty says it's helpful to think of AR's impact in terms of Apple's launch of the App store in 2008. The store created a huge new market on smartphones and changed how people interact with the computers in their pockets. It added functionality, personalization and value to everyone's phones.

Augmented reality is being enabled by the new camera and sensor technology being added to phones, which allow the cameras to "see" depth and build on that information. AR technology has already been used to create virtual tape measures, virtual try-at-home furniture stores and the wildly popular Pokemon Go app.

'This has the potential to revolutionize applications, including social media, search, gaming, and eCommerce," Huberty said. "If we're right, both smartphone upgrades and mobile app revenues should accelerate."

Apple is expected to announce the next iPhone on Tuesday, and investors are hoping the new wireless charging and bezel-less screen of the phone will drive a "supercycle" of upgrades from consumers. Huberty said she will be focusing on the augmented reality technology that Apple announces instead.

The company is already outpacing its rivals in the industry. Apple announced ARKit earlier this year, which lets developers more easily build augmented reality apps for iPhones, and the community has already grabbed ahold of the technology. A Twitter account documenting the cool apps developers are creating has had several viral tweets showing off the new tech already.

Google recently offered its own AR development kit, called ARCore. Huberty notes that the tech only works on Pixel and Samsung devices right now, which limits its potential user base.

The timeline for AR is long, but simple, according to Huberty. Dual lens cameras on smartphones, which are required for more accurate, real-world tracking, are currently on only 3% of the world's smartphones. Once that adoption rate hits about 20%, we will see an inflection point in AR, Huberty said. This could happen as early as 2018, according to Huberty's models.

Between its first-to-market ARKit, and the emphasis on AR in its new phones, Apple is set to rock the competition. In her note, Huberty increased her bull-case price target to $253 for the company, up from her previous $203 target, and 57.2% higher than the company's current price. At that price, Apple would be worth about $1.27 trillion.

To follow along with Apple's stock price throughout the iPhone announcement day, click here.

Apple is up 38.69% this year.