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Communications Sector Rating: Underperform

By

Brad Sorensen

photo
CFA, Managing Director of Market & Sector Analysis, Schwab Center for Financial Research

Brad Sorensen heads market and sector analysis for the Schwab Center for Financial Research and writes for several Schwab publications. He is a member of Schwab's Investment Strategy Council.

Before joining Schwab in 2004, he was a senior analyst at AMG Guaranty Trust, where he designed portfolio strategies for high-net-worth individuals. Sorensen graduated from the University of Colorado with a bachelor's degree in finance and master's degrees in business administration and finance. He is a Chartered Financial Analyst charterholder.

October 01, 2018

Member for

1 year 8 months
Submitted by satya.billa on Mon, 10/01/2018 - 10:03
Communication Services Sector

Communications sector overview

Rapid growth in large portions of the group may start to slow as saturation points may be reached and competition comes online. Costs also seem likely to go up as the fight for consumers escalates.

Market outlook for the communications sector

The recently formed communications sector certainly has some of the most exciting and cutting-edge companies involved in it. The ways we all communicate and consume media are involved in this group and there is hardly an American that isn’t in contact with multiple companies within the group on a daily basis. But that also leads to intense competition for those consumers’ attention, and to us there is the potential that some of the current leaders in the sector may be reaching saturation points, which could result in at least a temporary slowdown in the growth rate in a good-sized portion of the group. As a result, we are rating the communications sector at underperform for the time being.

There is no doubt that some of the most exciting companies in the U.S. are members of the communications sector. New methods of communication, new content, and new ways to consume content are all likely interesting to most investors. They certainly are interesting to advertisers, who are constantly looking for new ways to target their potential consumers. And even more exciting may be the potential rollout of the next generation of wireless technology—so-called 5G. This rollout has the potential to affect the rest of the sector, as it would allow movies to be downloaded in seconds instead of minutes, while the number of devices able to be supported within a square kilometer is estimated to move from about 2,000 with 4G to about 1 million (Wall Street Journal).

But one concern we have is that all of this excitement costs money. Pursing new technologies and providing quality content has costs associated with it, and we believe that those costs are likely to grow over the coming year. Also, with some of the companies in the group growing into some of the largest-cap stocks in the U.S., they are attracting more attention from the government, which has expressed concern about both the size of some of these companies as well as their protection of the privacy of their consumers. Part of the reason  advertisers are so willing to spend an estimated $107 billion on online advertising in 2018 (eMarketer) is the ability of those online sources to better target those ads to specific consumers. If their ability to collect consumer data gets curtailed, their ability to grow revenues may be more limited.

While the communications sector has many exciting companies, we currently believe the stocks of many of those companies have risks that outweigh the potential rewards…at least for now, and are putting an underperform rating on the group.

Factors that may affect the communications sector

Positive factors for the communications sector include:

  • Increasing wireless demand: Demand is rising as more communication and media devices move to the wireless arena, providing the potential for revenues to rise. While the projected rollout of 5G technology could enhance that demand to an even greater degree.
  • Solid advertising demand: With good content and better ability to target consumers, advertisers may be more willing to up their spending with some of these companies.

Negative factors for the communications sector include:

  • Slowing revenue growth: With so many people already using many of the largest services in the group, future growth rates may start to slow.
  • Rising expenses: Expenditures in the communications space seem likely to increase as more content is needed and faster network speeds are pursued. This could be a burden on profitability.
  • Regulatory risk: With the size and collection of personal data by some of the biggest companies in the group attracting the attention of the government, new restrictions are a threat that could impact revenue growth.

Clients can see our top-rated stocks in the communications sector.

Want to learn more about a specific sector?  Click on a link below for more information or visit Schwab Sector Views to see how they compare.

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