Investors should buy Apple shares because the company is making a big bet on augmented reality, according to UBS, which reiterated its buy rating.

"According to some industry sources, the company may have over 1,000 engineers working on a project in Israel that could be related to AR [augmented reality]," analyst Steven Milunovich wrote in a note to clients Tuesday. "Our work suggests that AR could be the next major innovation from Apple and that its competencies could make the company a winner ... Augmented reality is an area where Apple could leapfrog competition in providing a superior user experience. This could result in sustained iPhone retention rates and more switchers."

Augmented reality is a technology that "overlays digital content on the real world through the device's camera view."

Milunovich raised his Apple price target to $151 from $138, representing 10 percent upside from Monday's close.

The analyst quoted Apple CEO Tim Cook comparing augmented reality innovation to the iPhone, saying, "I think AR is that big, it's huge."



Milunovich cited how the company bought multiple AR technology companies such as PrimeSense, Metaio and RealFace. Milunovich thinks it's possible an early form of AR may be released with the iPhone 8 later this year.

"Apple appears more interested in AR [augmented reality], which connects people, than VR [virtual reality], which potentially isolates experiences," he wrote. "Apple may be well equipped to lead given its core competencies in hardware design and software/hardware integration as well as its large base of affluent iPhone and iPad owners."



— CNBC's Michael Bloom contributed to this story.

