Changes to the Global Industry Classification Standard (GICS) come this week with the debut of the new S&P 500 communications services sector. As a result, the market will characterize more equities as “communications stocks.” Internet search, social media, mass media, telecom and electronic gaming stocks will make up the bulk of this sector.
The communications services sector makes up around 11% of the S&P 500. Meanwhile, analysts expect the technology sector to fall from about 26% to 20% of the index. Consumer discretionary will likely drop from the 13% range to around 11%. The telecom sector, currently about 2% of the S&P, now disappears. Now, all telecom equities are considered communications stocks.
Since June, investors have had the option to invest in communications stocks by sector with the Communication Services Select SPDR Fund ETF (NYSEARCA:XLC). This fund contains many popular, but arguably overvalued companies such as Netflix (NASDAQ:NFLX) and Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL), the fund’s largest holding at about 24.5%. However, many stocks in this index trade at reasonable valuations.
Investors wanting to get into this sector outside of an ETF should look at the following communication stocks to buy:
Facebook (FB)
Facebook (NASDAQ:FB) makes up the largest percentage of any single stock in the XLC fund (the Alphabet stake is divided between GOOGL and GOOG). Since FB stock makes up 17% of the holding, the ETF took a hit when FB suffered the single largest daily market cap loss by any stock.
The Cambridge Analytica scandal, as well as accusations of left-leaning bias and Russian collusion, weighed on FB stock for much of the year. However, despite the negative sentiment of late, FB remains the dominant communications stock in the social media space. The user base stands at over 2.2 billion. Its Instagram site also boasts over one billion monthly active users. Peers such as Weibo (NASDAQ:WB) and Twitter (NYSE:TWTR) see much smaller userbases. FB also owns four of the six apps that have attracted over one billion users. Furthermore, the company dominates social media advertising, the primary source of company revenue.
The fact that FB trades at about 25% below its August high gives investors a reason to jump into FB stock. Facebook now holds a forward price-to-earnings ratio of 22.7. This constitutes a low multiple for a stock expected to grow its profits by 33.2% this year and 16% next year.
Given the focus on scandals, FB stock may continue to suffer in the near-term. It holds over $42 billion in cash. Using some of that cash to begin paying dividends could turn around the stock faster. Still, even if that does not occur, I think its low multiple and high growth rate will eventually bring investors back to FB stock.
Comcast Corporation (CMCSA)
Comcast (NASDAQ:CMCSA) finds itself in transition. As the country’s largest cable provider, it has suffered as consumers cut the cord in favor of lower-cost internet streaming services. Thankfully, Comcast also provides broadband internet to millions of consumers. Additionally, this communications stock makes up over 5.3% of the XLC fund.
It has become an increasingly large player in the content market. It purchased NBCUniversal from GE (NYSE:GE) many years ago. Comcast recently lost the bidding war on the assets of Twenty-First Century Fox (NASDAQ:FOXA, NASDAQ:FOX). Still, it won another bidding war for a majority stake in Sky (OTCMKTS:SKYAY), which means the company will continue to be competitive with regards to the level of media content it controls.
Despite these holdings, CMCSA stock trades at a forward multiple of around 15. Also, the company has maintained double-digit profit growth over the last five years. Analysts expect this to continue for years to come. They forecast 22.8% profit growth this year and a 10.3% rate of increase in profits for next year.
Investors also receive a dividend. The 2% yield will serve as more of a bonus than a reason to buy. However, other than the dividend cut in 2017, it increased every year since its introduction in 2008.
Despite its struggles, the cable provider has made the strategic pivots necessary to remain a relevant communications stock. Its growing content library only adds value to the company. With a low P/E and a double-digit growth rate, investors should pay more attention to CMCSA stock.
Activision Blizzard (ATVI)
The XLC fund places almost 5% of its assets in Activision Blizzard (NASDAQ:ATVI). This communications stock stands out among its main domestic peers, Electronic Arts (NASDAQ:EA) and Take-Two (NASDAQ:TTWO). XLC holds almost as large of a stake in ATVI stock as it maintains in EA and TTWO combined.
I agree with the fund manager’s allocation in this case. The gaming giant continues to lead on innovation in its industry. Next-gen gaming and esports drive its path forward. Competitive gaming has taken off as its Overwatch League, founded only last year, begins to rise in popularity. Although the current landscape remains competitive, its Call of Duty series should continue to generate profits.
With a 30.4 forward P/E, the valuation looks a little high. However, the stock supported an average P/E of 45.5 over the last five years. Moreover, ATVI saw average annual growth of 36.2% over the previous five years. Over the next five, analysts still expect 14.9% growth. That could move higher as more people tune in to Overwatch matches.
The stock currently trades near 52-week highs. It has also trended steadily higher since 2012. Stocks at 52-week highs tend to keep moving higher. Moreover, the multiple comes in below its own averages, even though the company continues to serve as an innovation leader for the electronic gaming industry. Given these factors, I think ATVI deserves to trade at a premium.
AT&T (T)
At first glance, AT&T (NYSE:T) might seem like a strange choice. Razor-thin profit margins in wireless, fewer homes with landline phones, and cable cutting have all weighed on T stock. Moreover, having to spend tens of billions of dollars to build a 5G wireless network will only put further pressure on the communications stock.
However, 5G networks will finally start to bring in revenue this year. Also, assuming Sprint (NYSE:S) and T-Mobile (NASDAQ:TMUS) merge, AT&T will own one of the three nationwide 5G networks in existence. Moreover, with the cost of a 5G build-out, new entrants remain unlikely. This technology brings a quantum leap in both internet speeds and capabilities, and it will likely bring capabilities to the market not yet available. As such, almost 4.9% of XLC fund assets reside in T stock.
Due to its recent challenges, the forward P/E ratio stands at around 11.1. Wall Street also expects 14.8% profit growth for this year. That will slow to 4% next year and average in the mid-single-digits for years to come.
While that growth may not sound high, its dividend may. Its annual dividend of $2 per share yields almost 5.9%, more than triple the S&P 500 average. Also, the T stock price depends heavily on yearly dividend increases. This streak has held since 1985. Most analysts believe that the company will announce the 34th consecutive increase in December.
AT&T has seen many challenges over the last few years. However, this has placed T stock at a low valuation. It also forces the company to pay a high dividend that has become politically difficult to cut. This situation puts T stock in a place where both growth and income investors can enjoy profits while both the PE and dividend yield move toward long-term averages.
Disney (DIS)
Disney (NYSE:DIS) failed to meet expectations as its latest Lucasfilm offerings, Star Wars: The Last Jedi and Solo: A Star Wars Story disappointed at the box office. This has placed upcoming Lucasfilm movies in limbo. Also, cable cutting has left the Disney Channel and ESPN with fewer viewers. As a result, DIS stock has remained range-bound for nearly four years.
Despite these challenges, Disney’s theme parks have continued to generate large amounts of profit. Moreover, success in another sector will likely occur soon. Disney will launch a long-awaited streaming service for its non-sports content in 2019. This means a popular content library will soon leave Netflix, currently the No. 1 streaming service. With this move, analysts expect many of Netflix’s customers will also bolt to Disney.
By extension, that will probably also bring attention to DIS stock. Currently, Netflix supports a P/E of 137. Disney’s forward P/E stands at only 16.3. I expect Netflix will still maintain a higher growth rate than Disney, even after Disney’s content leaves the platform. Still, analysts expect a 21.6% rate of profit growth for DIS stock this year, and an average of 11.3% per year over the next five years. Currently, XLC’s fund managers hold over 4.8% of the fund’s assets in DIS.
DIS stock has suffered as viewers left its cable channels and gave its latest Lucasfilm movies mixed reviews. However, many, including myself, expect the Disney streaming service to breathe new life into the company. Moreover, with a low P/E and double-digit growth, I predict this offering will bring DIS stock back to growth.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.
