The case for Ericsson (NASDAQ:ERIC) is not particularly complicated. At its core, Ericsson stock is a play on the growth of 5G (fifth-generation) wireless worldwide.
After all, Ericsson is one of the few providers with the capability of manufacturing the critical equipment needed to provide 5G service. Meanwhile, perhaps its toughest competitor — China’s Huawei — has been hamstrung by political pressures.
There’s been an equally simple retort to that case, however: why, exactly, is this time different? Certainly, the speed provided by 5G has the potential to revolutionize multiple markets. I’ve compared the technology to the buildout of railroads in the 19th century.
In fact, 5G is going to be the biggest, most important, most lucrative new highway built in our lifetimes. And by investing in the companies building alongside the 5G highway, you’ll position yourself to get in on the new businesses and breakthroughs set to transform our world.
That said, I’m already looking everything you need to know to take advantage of this situation. And don’t worry, there is still time to get on board.
Overall, though, that doesn’t mean Ericsson necessarily will benefit. Its markets are competitive, and hardware manufacturing has not been a great business in recent years. Ericsson stock itself has been a bit of a disappointment, too.
So, collectively, it’s a fair concern. However, it’s also a concern that was answered by recent earnings reports from Ericsson and one of its biggest rivals.
The Case Against Ericsson Stock
The Achilles heel of the case for ERIC stock is that 5G, as the name suggests, is not the first major upgrade for telecommunications equipment. It’s likely the biggest, and probably the most anticipated since mobile data first became ubiquitous. But Ericsson has benefited from worldwide demand for 3G and 4G equipment as well.
That said, this demand really hasn’t done all that much for Ericsson stock. Over the past decade, ERIC has risen just 23.2% — total. All of the gains, and then some, have come just in the last few weeks. The news, admittedly, is better including dividends. But a 50% total return still badly lags the broad market — and particularly, the tech sector.
It’s not just Ericsson, either. Over a decade, investors in rival Nokia (NYSE:NOK) have lost 41%. Zoom out to other networking plays, and the likes of Cisco Systems (NASDAQ:CSCO), Motorola Solutions (NYSE:MSI) and Juniper Networks (NYSE:JNPR) too have underperformed the NASDAQ Composite (while admittedly topping ERIC and NOK).
Nonetheless, a key part of the underperformance for Ericsson stock is the rise of Huawei. The Chinese giant not only has taken market share, but undercut on pricing. And as a result, we’ve seen margin and profit pressure for the Western operators in the space.
Why Earnings Matter
With all of the above in mind, that’s why Ericsson’s earnings beat last month is kind of a big deal.
Admittedly, on its face the report doesn’t look all that impressive. Adjusting for comparability and currency, revenue was flat year-over-year.
But, of course, the novel coronavirus pandemic played a role, as it delayed some projects into the second half of the year. And it’s not the top line that truly makes the report interesting.
Rather, it’s the fact that even in a pandemic, Ericsson was able to drive margin expansion. Excluding restructuring charges, operating margins expanded 150 basis points YOY. As a result, adjusted net income grew nicely YOY.
In turn, that growth crushed analyst estimates. In other words, not even Wall Street expected that kind of profit improvement.
The Case for ERIC
Of course, a single earnings beat doesn’t define a bull case. I’ve consistently advised investors to take the long view across the entire market, and that advice applies here as well.
However, it’s worth noting that Ericsson wasn’t the only company in the sector to beat earnings. Nokia too posted strong bottom-line growth.
So now, we’re seeing a story that matters to Ericsson stock long-term. Huawei is under pressure worldwide, and that pressure limits a key competitor in Western markets.
As a result, even during a pandemic, Ericsson and Nokia have renewed pricing power. And with operating margins still relatively thin — Ericsson’s adjusted figure was 8.2% in Q2 — that power suggests substantial profit growth if revenues grow.
Moreover, those revenues are likely, and almost certain, to grow. 5G is real, it’s coming, and it’s going to be worldwide. Wireless operators cannot risk falling behind peers.
What Q2 suggests is that the decade-long underperformance in ERIC and NOK may well be ending. And simply put, it suggests that these are better businesses than investors and analysts believed just a few months ago.
So with Ericsson likely the better pick of the two, and ERIC stock still reasonably valued, that means the recent rally likely isn’t over. And if Q2 really is a harbinger of what’s to come, Ericsson stock can be a long-term winner as well as a short-term one.
That said, 5G is the groundbreaking new wireless network being built out across America right now. It’s the successor to the 4G network our phones and devices currently run on.
If I could, I’d go door to door across America and help people take advantage of this opportunity, which is bigger than the internet. However, I can’t do that — so I’m doing the next best thing.
My colleagues and I have spent a lot of time and money getting this message out: I believe the 5G boom will be a life-changing event for investors. And it could mean big things for you personally.
Now, you’re probably asking yourself how. Well, you can get started right now by taking a look at my brand-new report called The 5G Highway Super Portfolio.
Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. Click here to see what Matt has up his sleeve now. As of this writing, Matt did not hold a position in any of the aforementioned securities.