Investing in Communication Stocks

Updated: Aug. 26, 2020, 12:02 p.m.

The communication services sector encompasses two kinds of companies:

  • Information technology companies use computers and software to help businesses and individuals stay connected.
  • Telecommunications companies provide infrastructure and services to distribute information through television transmissions, broadband internet, mobile wireless, and more.

Stock returns for leading telecommunications companies have lagged those of top tech companies in recent decades. But no other broadly defined sector has driven more economic expansion over the last century, and communications companies will continue powering growth in the decades to come.

The best communication stocks of 2020

AT&T

This company operates the U.S.’ second-largest mobile wireless network and is the country’s largest pay-television provider through its DirecTV subsidiary. AT&T's (NYSE:T) WarnerMedia division is also one of the world’s biggest and most influential entertainment businesses.

Economic conditions stemming from the coronavirus pandemic have intensified cord-cutting pressures at AT&T’s DirecTV business and created a more difficult environment for adding mobile wireless subscribers. WarnerMedia is also enduring challenges arising from conditions created by COVID-19, with movie theaters remaining in limited operation and many sporting events and entertainment productions shut down or delayed. However, the telecom giant pays a great dividend, and its strengths in mobile wireless position it to benefit as 5G network availability and adoption increase.

Verizon

Verizon (NYSE:VZ) has more mobile wireless subscribers than any other U.S. carrier, and its user-base advantage and top-rated service have the telecom leader positioned to benefit as consumers and businesses adopt 5G. The company has less exposure to the declining pay-TV space compared to AT&T, while also lacking its chief rival’s strengths in entertainment content.

Verizon is more focused on mobile wireless service, but it has media ventures of its own. That means the company is facing a weaker market for its advertising-based businesses because of COVID-19 -- in addition to increased wireless service churn and greater difficulty bringing new customers into its network.

Despite near-term headwinds, Verizon’s business still looks sturdy. Next-generation wireless service could become a substantial growth driver, and the company pays a sizable and sustainable dividend in the meantime.

Netflix

The pioneer of subscription-based streaming video in the U.S., Netflix (NASDAQ:NFLX) has built a massive audience in the country. The company is quickly expanding its business around the globe and still has a long runway for growth as it expands content offerings in international markets and raises subscription prices.

While many companies are struggling amid the coronavirus pandemic, the unprecedented conditions have actually boosted demand for streaming content. The tougher economic climate is accelerating cord-cutting trends and bringing new subscribers to Netflix’s service. The streaming leader is reaping the rewards of having the right product at the right time, and it’s poised to benefit from the ongoing decline of cable and rising global demand for entertainment content.

Facebook

With billions of users across its collection of social media platforms, Facebook (NASDAQ:FB) is a huge player in communications. The company generates tremendous revenue from digital advertising services integrated across Instagram and its namesake social network, and its user base’s incredible size and levels of engagement present opportunities to expand into areas including digital payments and e-commerce.

Facebook has plenty of growth potential, but the company is facing a more challenging business climate in the near term because of COVID-19. Economic uncertainty tends to mean that advertisers are cautious with spending because driving sales is more difficult, but social networks and digital advertising are here to stay -- and engagement for both will likely continue climbing over the long haul.

Alphabet

Alphabet’s (NASDAQ:GOOG)(NASDAQ:GOOGL) Google division is responsible for the world’s top search engine and digital advertising platform -- among other leading communications-related products and services. YouTube is the most watched video-streaming service in the U.S., Gmail is the world’s second-most-used email client, and the company’s Android platform is the world’s most-used mobile operating system and serves as a foundation for a huge array of third-party applications.

Like Facebook, Alphabet derives the majority of its revenue from digital advertising. Near-term challenges aside, Alphabet is poised to continue benefiting from its leadership in the search engine space -- and its big investments in artificial intelligence will likely strengthen its core ad business and pave the way for new growth opportunities.

An internet modem with cables attached.

Image Source: Getty Images

How to analyze communication stocks

The communication sector is broad, encompassing many different fields, so it’s generally best to compare communication companies that mostly operate in the same industries or are at similar stages of growth.

Keeping track of user-base levels and engagement trends can provide insights into how a business or product is performing relative to the competition and what a business’s earnings trajectory might be in the near term. Investors can use this data to estimate how much revenue or earnings a company, business segment, or individual service is generating per user and how performance might shift if per-user monetization or overall user-base size were to change.

Companies that return cash to shareholders through dividends can deliver strong returns even if the businesses are increasing earnings relatively slowly. Within the communication services sector, telecommunications companies are more likely to pay big dividends than information technology companies.

Earnings growth for telecoms typically lags behind that of leading information technology companies, but dividend payments can create the potential for dependable returns and incentivize stock ownership. When analyzing dividend stocks, it’s a good idea to pay attention to metrics including dividend yield and the number of consecutive years a company has increased its payout.

With the COVID-19 pandemic creating new costs and other business obstacles, it’s also especially important to monitor the percentage of earnings or free cash flow that companies require to cover their dividend distributions. Weakened business performance can mean that a company can no longer afford to cover its payouts, and cutting or suspending a dividend typically means big stock price declines.

Investors should also pay attention to a company’s expenses and whether spending is paying off over time. Within the telecommunications space, it’s important to keep track of capital expenditures -- the amount companies are investing to acquire and maintain crucial infrastructure such as internet cables, satellites, and cell towers. Within the information technology space, investors should look at research and development (R&D) and content spending to get an idea of how much companies are putting into creating technology and products that can drive growth.

Why the communications sector has big growth potential

Communications services and content will continue to have a big impact on economic development. With computing platforms playing a growing role in everyday life, and 5G internet set to bring about dramatic improvements in network speeds that will pave the way for advancements in fields like autonomous vehicles, smart cities, and virtual reality, telecommunications and information technology companies will experience and create demand for a wide variety of services and products. Investors who back top companies and hold for the long term will likely enjoy strong returns from the communications space.

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