- Today, we’ll discuss whether or not the top 10 global telecoms are value traps or if they are value investments.
- There’s a lot going on in the sector, from 5G to the internet of things.
- The lowest risk higher reward investment strategy might not come from the biggest companies in the field.
I’m constantly coming across stocks from the telecom sector that have a low valuation and a strong dividend. Today, we’ll discuss whether or not there is value or if the whole sector is a value trap.
The Telecom Sector
As always, the best way to look at a sector is to look at an ETF.
The iShares U.S. Telecommunications ETF (NYSEARCA: IYZ) has an extremely low price to book ratio at 1.47, a dividend yield of 3.5%, it’s close to its 52-week lows, and hasn’t really gone anywhere in the last 3 and a half years even as the market rallied.
A look at the top 5 stocks in the sector from the U.S. and Europe will give us a better perspective. I’ve looked at revenue and earnings growth over the past 3 years, dividends, price to earnings ratios, and price to book values.
What’s to be seen from the table above is that the dividends are mostly high, growth mostly comes from acquisitions, earnings are flat or declining, and price to earnings ratios are lower than the market average but not really that low. TMUS has a higher growth rate but also has an average market valuation.
Many see telecoms as safe and secure companies that will protect a portfolio in a bear market, but that’s something to rethink especially as the companies above have been pilling up with debt to sustain their high dividend payments. Further, the telecom ETF fell 60% in the last bear market while the S&P 500 fell 50%.
Given that the valuations are stretched, growth is mostly achieved through acquisitions, and debt is used to pay dividends, the outlook for the sector isn’t the best and therefore, the relative cheapness is justified. Let’s see if the future will bring better news given all the new, exciting technologies coming.
Recently, AT&T announced the introduction of 5G technology in a few states in the U.S. while Verizon also plans to introduce it in a few states. Further, AT&T has plans for growth coming from South America, while Verizon plans to see growth from the 5G technology application.
However, as with every new telecom technology, the upfront investments are significant, the battle for market share is merciless, margins are tight, and you never know how fast it will be before a new disruptive technology comes out that makes your previous investments worthless. Let’s see what could disrupt the sector.
Sector Disruptors – Threats & Opportunities
The main disruptors for the telecom industry are still companies like Skype and WhatsApp, and perhaps we still haven’t yet experienced the true power of that disruption. For example, a Dutch telecom operator lost €100 million in revenue in the same quarter that WhatsApp was introduced.
The point is that the goal of all disruptive technologies is to make things cheaper and faster. If you make things cheaper, it has an inevitable negative impact on revenues and profits. We’ve already seen the impact of this disruption in the stagnating revenues and declining earnings of the operators discussed above.
We’ve been living in an environment of almost free money and economic growth for the past 8 years. Even if considered defensive, I doubt that the telecom sector’s debt-financed dividends will be sustainable in the next recession or if we see higher interest rates. Thus, even if the dividends seem tempting, I really wouldn’t sit in such stocks because things can go bad very quickly.
Being invested in telecoms is also too risky because they are going to spend their cash on capital expenditures and the importance of their infrastructure can change very quickly.
It isn’t even necessary for someone to really change the way we communicate, it’s just necessary that somebody announces it. For example, Facebook has a goal to provide communication to the whole world by beaming internet form the sky. If they manage to deliver on this goal, it won’t take long for Facebook to offer communication services in developed markets for a fraction of the price.
There are changes on the horizon with lots of risks and uncertainties, so how should you invest?
How To Invest In Disruptors Of The Telecom Industry
Do you know who got rich in the midst of the gold fever of the 1800s? It was the person selling pikes and shovels.
If you want to take advantage of the upcoming disruptions in the telecom sector, including the rise of the internet of things and 5G technology, try to look for those companies that are indispensable to anyone trying to sell a product, i.e. technology producers.
Keep reading Investiv Daily as I’ll soon dig into the investing opportunities of the 5G disruption. It isn’t yet an hyped trend, so there is still time to invest and help us leave the telecom behemoths in the past.