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Communications Sector Rating: Underperform

Communications sector overview

The sector has underperformed over the past three months, as concerns about regulatory issues and growth rates appear to be growing. Costs also seem likely to go up as the fight for consumers escalates and competition heats up.

Market outlook for the communications sector

For the first part of the year our underperform rating wasn’t looking so good, but over the last three months the group has trailed broader market performance. A growing number of headlines regarding the possibility of government intervention appears to be the biggest reason for the recent underperformance, but it likely isn’t the only one. The communications sector certainly includes some of the most exciting and cutting-edge companies, 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. To us, this raises the potential that some of the current leaders in the sector may be reaching the saturation point, which could result in at least a temporary slowdown in the growth rate of a good-sized portion of the group—a possibility more investors may be paying attention to.

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 that can be supported within a square kilometer is estimated to move from about 2,000 with 4G to about 1 million with 5G (The Wall Street Journal). However, some of that enthusiasm appears to be dimming at least somewhat, as the costs and technical challenges, along with the Trump administration apparently targeting one of the leaders in 5G from China (Reuters), may be reducing near-term expectations.

This adds to a major concern we have—that all of this excitement costs money. Pursuing new technologies and providing quality content has costs associated with it, and we believe 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 their size and how well they’re protecting consumers’ privacy. Part of the reason advertisers are willing to spend an estimated $333 billion on digital advertising in 2019—up 17.6% from 2018 spending, and roughly half of the global ad market (eMarketer)—is the ability of those online sources to better target ads to specific consumers. If their ability to collect consumer data were to be curtailed, their ability to grow revenues could 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. That’s why we continue to hold 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. Meanwhile, 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 increase 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 primary 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 affect revenue growth. Additionally, the recent restrictions placed on a major Chinese 5G technology provider could slow the rollout of the new platform. 

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.

Communications Consumer discretionary Consumer staples Energy
Financials Health care Industrials
Information technology Materials Real estate
Utilities

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