Communications sector's stocks go from ‘stodgy’ to ‘edgy’

Telecom stocks have outperformed the broader index in US dollars in four of five bear markets since 1990. AFP

Will communications industry's stocks’ surge continue? While tech is 2024’s top-performing global sector – surprising no one, given artificial intelligence enthusiasm and more – the communication services sector is a mere wiggle behind. Yet many have never even heard of it.

So what is this sector? And can its hot performance last? As I will show you, this sector is a quirky mix of growthy, tech-adjacent firms and old, stodgy telecom, a split saga of diverging industries. Let me explain.

Communication services as a sector didn’t exist before 2018. It was previously the telecoms sector – comprising classically defensive, highly regulated, slow-growth behemoths. Telecoms had steady revenues, big dividends and low volatility – far from economically sensitive.

America’s S&P 500, used here for its long history of accurate sector data, illustrates this: Telecom stocks outperformed the broader index in USD in four of five bear markets since 1990 – the exception being 2000 – 2002, when fantasies like WorldCom, Global Crossing and Lucent fantastically imploded.

Good defence meant bad offence, though. Telecom stocks also lagged in four of the last five bull markets – hugely. The average underperformance? A whopping 128 per cent!

Since October 2022’s low in USD, S&P 500 telecom’s return is just under half the broader index’s. Huge lag!

Then, in 2018, index providers S&P and MSCI meshed several giants from US tech with stale telecom, creating the new “communication services” sector. This changed everything.

In society and the sector, boring phone lines yielded to search engines, social media and online commerce – tech-like growth. The old telecom industry is still there, but it is just over one-sixth of the new sector’s market cap.

Meanwhile, the interactive media and services industry dominates, comprising 62 per cent of the sector. Nearly all of that is American – almost 90 per cent – while Hong Kong-listed firms run a distant second.

You know the industry’s biggest names – Meta and Google parent Alphabet. But it also includes online dating, recruiting, web-based auto selling and buying firms and more – with super-low barriers to entry compared to telecom’s costly wirelines and towers.

Communication services also includes the entertainment industry, 14 per cent of market cap – home to big streaming and gaming firms. Tech-like, too!

The other 6 per cent is media – think cable providers, TV networks, news companies and advertisers.

Hence, large parts of this diverse sector act like tech: low dividends, fat gross operating profit margins (GOPM), big reinvestment in innovation, buzzy products and services … and huge growth.

These tech-like tendencies juiced returns in up markets – including 2024’s.

Consider: Interactive media and services is up 26.9 per cent globally year to date, driving communication services’ 17.2 per cent overall return.

That is neck and neck with tech’s 18.2 per cent – and nearly doubles global stocks’ overall 9.8 per cent climb.

The sector's entertainment industry firms are up 13.2 per cent, too. But its telecom segments languish: wireless telecom gained just 4.3 per cent while diversified telecom is flat.

This divergence largely parallels performance throughout this global bull market. Since October 2022’s low in USD, communication services has roared 67.3 per cent globally, easily topping world stocks’ 48 per cent gain.

Again, interactive media and services won biggest – up 105 per cent over that span, topping even tech’s 92.1 per cent.

But entertainment is the only other industry topping world returns since 2022’s low – and barely, at 49.4 per cent.

Few envisaged tech-like parts of communication services soaring back in late 2022 – just the opposite, after they heavily lagged in the 2022 decline. But they did!

Sentiment got too sour towards their outlook. Then, amid the doom and gloom, markets looked forward, foretelling a rebound. Stocks always pre-price economic and corporate realities three to 30 months ahead.

Their pre-pricing proved prescient. Interactive media and services’ first quarter earnings per share soared 14.5 per cent year-over-year, trouncing the MSCI All-Country World Index’s overall 0.5 per cent EPS growth.

World communication services’ earnings grew even more – 32.7 per cent year-over-year.

So what now? Expect more strength from big, tech-like communication firms. They should continue thriving as corporations switch to offence after two years of cost-cutting. Their fat GOPMs let them self-finance growth as spirits warm.

The advertising market, which so many of these firms capitalise on, should reheat, too.

Consider: Communication services’ GOPM is 44 per cent, easily topping world stocks’ overall 30 per cent. The fattest reside in interactive media and services, boasting mammoth 62 per cent GOPM. That tops even the tech sector’s 40 per cent.

That is where the leaders should be. Big US firms provide the juiciest opportunities – so shop those. Hong Kong offers some, too, although political uncertainty reigns there.

Then watch as these tech-like stocks help drive 2024’s bull market higher.

Ken Fisher is the founder, executive chairman and co-chief investment officer of Fisher Investments, a global investment adviser with $250 billion of assets under management