What is the Communication Services sector?
It includes fixed-line and wireless providers, social network companies, cable, media and content providers.
The Communication Services sector is concentrated in a handful of cutting-edge companies with which nearly all Americans have contact on a daily basis—including search engine (Google) and social media companies (Facebook), streaming services & entertainment (Netflix, Disney) and wireless & cable telecommunications companies (Verizon, AT&T, Comcast), to name a handful of the largest companies.
COVID-19 has had a positive impact on the overall sector performance, as some bigger companies within the key segments have had a tailwind from social distancing, which has increased demand for social media and streaming entertainment. However, there has been a mixed impact on integrated telecom, as those with primarily wireless product line have far outpaced those with business land-line services, which are being negatively impacted by the recession. Meanwhile, multimedia, theme parks and traditional advertising-focused broadcasters have faced significant headwinds.
The larger companies that enjoy significant competitive advantages due to their dominance in their respective business lines—search engine, social media and telecom—also face emerging antitrust risks. The rollout of fifth-generation (5G) cellular wireless technology could increase demand, as 5G is expected to increase speeds and allow for more exposure to the “Internet of Things” and automated car technologies—increasing growth potential. However, upgrading networks will require substantial capital investment and the pandemic has slowed the progress.
There is clearly a confluence of positives and negatives to consider from a qualitative perspective. When we assess the pros and cons through a more quantitative lens, we have a slightly more positive picture. The sector has been more sensitive to overall market moves recently, so a continued rally would be a macro tailwind. And long-term relative strength has been near the top. In terms of relative valuations, the few individual companies that compose more than 50% of the sector are difficult to assess. And the current Communication Services sector was launched in 2018—it replaced the narrower Telecommunications sector—so a comparison against the sector’s own history is not practical. This is compounded by the notion that the high-growth companies that dominate the sector are difficult to value. We can compare some of the fundamentals—such as return on equity and earnings revisions—with other sectors, and they are slightly below average, as upward earnings revisions have trailed other beaten-down sectors. We are concerned that the strong run-up in heavily-weighted growth stocks poses the risk of a rebalancing across the other sectors that could result in relative underperformance.
We believe that many Communication Services companies face unique risks, but their strong competitive advantages within the industry also afford them potential rewards. However, balancing that against macroeconomic, value, fundamental, and relative strength factors is neutral, in our view.
Sector Overview: Communication Services
Note: Each of the sector indicators shown above—Macroeconomic, Value, Fundamental and Relative Strength—is both intuitive and evidenced-based in nature. Within each, there are a varying number of factors. The Macroeconomic lens includes sector sensitivities to interest rates, stocks and the value of the U.S. dollar; the outlook for each of these is determined by the Schwab Center for Financial Research (SCFR)’s Asset Allocation Working Group, which uses a mosaic approach of quantitative and qualitative considerations. Value includes six different valuation metrics that provide a holistic perspective on current valuations relative to each of the sectors’ own historical valuations, as well as relative to the other sectors. Fundamental provides insight as to how efficiently the companies within each sector use invested capital to produce earnings; this historically has been informative as to future relative performance of the sectors. Finally, Relative Strength measures momentum of the individual sectors against all of the other sectors. We also consider the data in the context of factors outside the scope of these indicators—for example, geopolitical risk or central bank policy changes.
Source: Charles Schwab, as of 09/10/2020
What do the ratings mean?
The sectors we analyze are from the widely recognized Global Industry Classification Standard (GICS®) groupings. After a review of risks and opportunities, we give each stock sector one of the following ratings:
- Outperform: likely to perform better than the broader stock market
- Underperform: likely to perform worse than the broader stock market
- Marketperform: likely to track the broader stock market
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. Clients can log in to see our top-rated stocks in the Communication Services sector.
* As represented by the S&P 500 index
What You Can Do Next
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