Telecommunications Sector: What and How To Invest in It

The telecommunication sector is made up of companies that make communication possible on a global scale, whether through the phone, the internet, over airwaves, or cables. These companies create the infrastructure that allows data as text, voice, audio, or video to be sent anywhere in the world.

The largest companies in the sector are telephone operators (both wired and wireless), satellite companies, cable companies, and internet service providers.

Not long ago, the telecommunications sector consisted of a club of big national and regional operators. Since 1995, and due to the subsequent Telecommunications Act of 1996, the industry has been swept up in rapid deregulation and innovation.

In many countries around the world, government monopolies have been privatized and now face a plethora of new competitors. Traditional markets have been turned upside down, as the growth in mobile services outpaces the fixed-line, and the internet starts to replace voice as the staple business.

Evolution of the Telecommunications Sector

The telecommunications industry began in the 1830s with the invention of the electrical telegraph, the first mechanical communications device. It shortened communication from days to hours. Telegraph networks relied on an extensive infrastructure and hundreds of highly-trained operators to relay messages in Morse code.

Over time, new inventions broadened the telecommunications industry. Each of the following inventions allowed the creation of new telecommunications networks that expanded the ability to communicate over long distances:

• Telegraphs: Developed in 1830s, they allowed written messages to be exchanged quickly over land.
• Telephones: Invented in 1876, they allowed the transmission of the human voice, reducing the need for Morse code operators.
• Radio and television: Allowed transmission over the airwaves, eliminating the need for wired networks.
• Cellular and satellite networks: Reduced reliance on fixed telephone networks.
• Computers and the internet: Allowed automatic transmission of information much faster than was possible through human speech or text.

The sector's structure has also changed from a few large players to a more decentralized system with decreased regulation and barriers to entry. Major public corporations act as the service providers, while smaller companies sell and service the equipment, such as routers, switches, and infrastructure, which enable this communication.

How Telecommunications Companies Make Money

Telephone calls continue to be the industry's biggest revenue generator, but thanks to advances in network technology, this is changing. Telecom is growing less about voice and increasingly about video, text, and data.

High-speed internet access, which delivers computer-based data applications such as broadband information services and interactive entertainment, has been making its way into homes and businesses around the world. The broadband telecom technology Digital Subscriber Line (DSL) once ushered in a new era. The fastest growth now comes from services delivered over mobile networks.

Of all the customer markets, residential and small business are arguably the toughest. The many competitors rely heavily on price to slog it out for households' monthly checks. Success rests largely on brand name strength and heavy investment in efficient billing systems.

The corporate market, on the other hand, remains the industry's favorite. Big corporate customers, that are concerned mostly about the quality and reliability of telephone calls and data delivery, are less price-sensitive than residential customers.

Large multinationals, for instance, spend heavily on telecom infrastructure to support far-flung operations. They are also happy to pay for premium services like high-security private networks and video conferencing.

Telecom operators also make money by providing network connectivity to other telecom companies that need it, and by wholesaling circuits to heavy network users like internet service providers and large corporations. Interconnected and wholesale markets favor those players with far-reaching networks.

Key Telecommunications Industry Segments

The telecommunications sector consists of three basic sub-sectors: telecom equipment (the largest), telecom services (next largest), and wireless communication.

The major industry segments within these sub-sectors include the following:

• Wireless communications
• Communications equipment
• Processing systems and products
• Long-distance carriers
• Domestic telecom services
• Foreign telecom services
• Diversified communication services

Wireless communications is a very fast-growing sub-sector industry. More and more communications and computing methods are shifting to mobile devices and cloud-based technology. These areas of the industry represent the anticipated keystone for the continued global expansion of the telecommunications sector.

Looking forward, the sector's biggest challenge is to keep up with people's demand for speedier data connectivity, higher resolution, quicker video streaming, and ample multimedia applications. The need for faster and better connections as people consume and create content requires significant capital expenditures. Companies that can meet this need may thrive.

Investing in Telecommunications

Telecommunications companies are a rarity among equities. At times, they have exhibited characteristics of both income and growth stocks. For growth investors, the small companies offering wireless services have provided opportunities for share price appreciation. In contrast, larger companies dealing with equipment and services have offered havens for conservative, income-focused investors.

Value investors also may find good pickings in the telecommunications sector. The need for telecommunications services, an integral part of the global economy, persists regardless of changes in the business cycle.

However, while the demand is constant, individual suppliers can rise and fall. For several years, a company may enjoy its regulatory privileges (like other utilities, telecom firms often are protected from competition by government mandate), and produce reliable, generous dividend yields (generated by high monthly revenue from its stable customer base). Then, suddenly, technological advances or mergers and acquisitions can create uncertainty and leave room for loss—and recovery, with fresh growth.

If a firm hits a slump because of shifts in the industry (like the growing importance of wireless devices), value investors might snap it up, provided its fundamentals remain strong and it proves adept at adapting to change. The telecommunications sector's record of paying and regularly raising dividends makes the waiting period for share price improvement more enjoyable (and potentially lucrative for those income investors mentioned above).

When sizing up their telecom sector investment options, investors should be aware of the changes in fortune of companies and the gap in revenue and market capitalization between telecom operators and large tech companies.

All three major telecom sub-sectors present some risk to investors. Investors with heavy exposure to telecom can expect stronger-than-average gains during bull markets. But, when a recession or bear market hits, losses can be severe.

Evaluating Telecommunications Companies

It's hard to avoid the conclusion that size matters in telecom. It's an expensive business. The telecom sector is capital-intensive and requires constant innovation to stay competitive. Depending on the sector a company operates in, there can be high overhead expenses, putting a squeeze on profit margins.

Contenders must be large enough and produce sufficient cash flow to absorb the costs of expanding networks and services that become obsolete seemingly overnight. Transmission systems need to be replaced as frequently as every two years.

Big companies that own extensive networks—especially local networks that stretch directly into customers' homes and businesses—are less reliant on interconnecting with other companies to get calls and data to their final destinations.

By contrast, smaller players must pay for interconnection more often in order to finish the job. For little operators hoping to grow big one day, the financial challenges of keeping up with rapid technological change and depreciation of equipment can be monumental.

Earnings can be a tricky issue when analyzing telecom companies. Many companies have little or no earnings to speak of. To gauge a company's value, telecom industry analysts might turn to the price-to-sales ratio (stock price divided by sales). They also look at average revenue per user (ARPU), which offers a useful measure of growth performance, and the churn rate, the rate at which customers leave (presumably for a competitor).

Big Players in Telecommunications

Industry leaders worldwide can change from year to year. Determining the largest depends on the valuation figure viewed. For example, that might be total revenue or market capitalization. As of May 2023, the top five telecom companies ranked by market capitalization are:

1. China Mobile (0941.HK), which primarily provides mobile voice and data services, broadband, and related services in Mainland China and Hong Kong, has a market capitalization of approximately $188.42 billion.
2. Comcast (CMCSA), a global media and technology company, has a market capitalization of approximately $169.71 billion.
3. T-Mobile US Inc. (TMUS), a major U.S. wireless carrier offering data plans as well as consumer and business telecommunications services, has a market capitalization of approximately $169.65 billion.
4. Verizon (VZ), which provides wireless and wireline services in addition to broadband and information services, has a market capitalization of approximately $158.99 billion.
5. AT&T (T), one of the oldest companies in the telephone business, has a market capitalization of approximately $122.40 billion.
   

Telecommunications ETFs

Exchange-traded funds (ETFs) can be an alternative to buying the stocks of individual telecom firms. Telecom ETFs have varying focuses on geography or industry specialization. Some of the most popular include:

• The Vanguard Communication Services ETF (VOX) is entirely composed of U.S. stocks, ranging from small, regional telecom firms to the big three, Verizon, AT&T, and T-Mobile.
• The iShares U.S. Telecommunications ETF (IYZ), similar in holdings to Vanguard's Telecommunication Services ETF, also tracks the largest telecom service companies in the U.S.—T-Mobile, AT&T, and Verizon—along with a handful of smaller regional service providers.
• The iShares Global Comm Services ETF (IXP) is more focused internationally, with more than 30% of its holdings in companies headquartered outside the U.S. Notable stocks include some of the top telecom companies: Verizon, AT&T, Comcast, and T-Mobile.

Other popular telecom ETFs include the Fidelity MSCI Communication Services Index (FCOM) and the SPDR S&P Telecom ETF (XTL).

Telecommunications Sector Outlook

Analysts foresee that product innovation and an increase in mergers and acquisitions will only facilitate the continued growth and success of the telecommunications industry. There are many opportunities for investors, and an increase in investors will only serve to benefit the sector further.

The stability of the sector's growth, even during periods of recession, means that it is considered to be a solid defensive investment while maintaining its appeal to growth investors. Even during uncertain and volatile economic times, the steady demand for voice and data services, along with extensive subscription plans, assures a stable source of revenues for major telecom firms.

Telecommunications have become increasingly vital, which bodes well for the sector's continued growth and future prospects. The continuing advances in high-speed mobile services and internet connectivity keep spurring innovation and competition within the sector.

Much of the industry focus is on providing faster data services, especially in the area of high-resolution video. The driving forces are quicker and clearer services, increased connectivity, and multi-application usage.

Emerging market economies continue to be a boon for the industry, with the growth rate of the cell phone industry in countries such as China and India pushing the abilities of hardware producers to keep up with the level of demand.

In the U.S., analysts are paying close attention to issues surrounding net neutrality as the demand for data and video services continue to increase well into the future. There is still a strong demand for wireless spectrum rights, not to mention an increasing trend toward consolidation through mergers and acquisitions.

The Bottom Line

Telecommunication companies, like other utilities, often operate with stable customer bases that are protected from competition by government mandate. These pseudo-monopolies allow for consistent dividends.

However, the dynamic nature of communications has led to mobile and internet-based phone systems and other important technological advances in the sector. When this happens, telecommunication companies can either suffer, or adapt and incorporate the new technology that can allow them to grow rapidly as consumers buy the latest equipment.