The Telecom Services sector ranks fourth out of the ten sectors as detailed in my Sector Rankings for ETFs and Mutual Funds report. It gets my Dangerous rating, which is based on aggregation of ratings of 5 ETFs and 13 mutual funds in the Telecom Services sector as of January 22, 2014. Prior reports on the best & worst ETFs and mutual funds in every sector are here.
Figure 1 ranks from best to worst all five Telecom Services ETFs and Figure 2 shows the five best and worst-rated Telecom Services mutual funds. Not all Telecom Services sector ETFs and mutual funds are created the same. The number of holdings varies widely (from 25 to 61), which creates drastically different investment implications and ratings. The best ETFs and mutual funds allocate more value to Attractive-or-better-rated stocks than the worst ETFs and mutual funds, which allocate too much value to Neutral-or-worse-rated stocks.
To identify the best and avoid the worst ETFs and mutual funds within the Telecom Services sector, investors need a predictive rating based on (1) stocks ratings of the holdings and (2) the all-in expenses of each ETF and mutual fund. Investors need not rely on backward-looking ratings. My fund rating methodology is detailed here.
Investors should not buy any Telecom Services ETFs or mutual funds because none get an Attractive-or-better rating. If you must have exposure to this sector, you should buy a basket of Attractive-or-better rated stocks and avoid paying undeserved fund fees. Active management has a long history of not paying off.
Get my ratings on all ETFs and mutual funds in this sector on my free mutual fund and ETF screener.
Figure 1: ETFs with the Best & Worst Ratings
* Best ETFs exclude ETFs with TNAs less than $100 million for inadequate liquidity.
Sources: New Constructs, LLC and company filings
Figure 2: Mutual Funds with the Best & Worst Ratings - Top 5
* Best mutual funds exclude funds with TNAs less than $100 million for inadequate liquidity.
Sources: New Constructs, LLC and company filings
Fidelity MSCI Telecommunications Services Index ETF (NYSEARCA:FCOM) is my top-rated Telecom Services ETF and T Rowe Price Media & Telecommunications Fund, Inc. (PRMTX) is my top-rated Telecom Services mutual fund. FCOM earns my Dangerous rating and PRMTX earns my Neutral rating.
State Street SPDR SPDR S&P Telecom ETF (NYSEARCA:XTL) is my worst-rated Telecom Services ETF and Rydex Series Funds: Telecommunications Fund (RYTLX) is my worst-rated Telecom Services mutual fund. XTL earns my Dangerous rating and RYTLX earns my Very Dangerous rating.
Figure 3 shows that 7 out of the 104 stocks (over 17% of the market value) in Telecom Services ETFs and mutual funds get an Attractive-or-better rating. However, 0 out of 5 Telecom Services ETFs and 0 out of 13 Telecom Services mutual funds get an Attractive-or-better rating.
The takeaways are: mutual fund managers allocate too much capital to low-quality stocks and Telecom Services ETFs hold poor quality stocks.
Figure 3: Telecom Services Sector Landscape For ETFs, Mutual Funds & Stocks
Investors need to tread carefully when considering Telecom Services ETFs and mutual funds. No ETFs or Telecom Services mutual funds in the Telecom Services sector allocate enough value to Attractive-or-better-rated stocks to earn an Attractive rating. Investors looking for exposure to the Telecom Services sector would be better suited to focus on individual stocks instead.
Verizon Communications, Inc. (NYSE:VZ) is one of my favorite stocks held by T Rowe Price Media & Telecommunications Fund, Inc. (PRMTX) and earns my Attractive rating. Over the past 10 years VZ has grown after-tax profit (NOPAT) by 19% compounded annually. VZ's return on invested capital (ROIC) of 8% is well above the industry average of 5%. On top of this, VZ has had positive and increasing economic earnings since 2008. At its current valuation of ~$48, I believe VZ is still very undervalued. Here is why: VZ has a price to economic book value ratio of 0.8, which implies that the market expects VZ's NOPAT to permanently decline by 20%. Given its growth over the past decade, this expectation seems overly pessimistic and highly unlikely.
Consolidated Communications Holdings, Inc. (NASDAQ:CNSL) is one of my least favorite stocks held by Telecom Services ETFs and mutual funds and earns my Dangerous rating. CNSL has grown after tax profits (NOPAT) by only 4% compounded annually for the last five years, and earns a bottom quintile return on invested capital (ROIC) of 5%. Since the company went public in 2005, it has yet to generate positive economic earnings. To justify its current valuation of ~$20, CNSL would need to grow NOPAT by 16% compounded annually for the next 14 years. The 16% growth rate seem unlikely given the company's slow pace over the past five years. Even less likely is the duration of growth, which implies that CNSL will increase NOPAT to ~$460 million, almost 60% higher than the current NOPAT of Sprint (NYSE:S). Investors should avoid CNSL, especially given the lofty expectations embedded in its current valuation.
37 stocks of the 3000+ I cover are classified as Telecom Services stocks, but due to style drift, Telecom Services ETFs and mutual funds hold 61 stocks.
Figures 4 and 5 show the rating landscape of all Telecom Services ETFs and mutual funds.
My Sector Rankings for ETFs and Mutual Funds report ranks all sectors and highlights those that offer the best investments.
Figure 4: Separating the Best ETFs From the Worst ETFs
Figure 5: Separating the Best Mutual Funds From the Worst Mutual Funds
Review my full list of ratings and rankings along with reports on all 5 ETFs and 13 mutual funds in the Telecom Services sector.
Kyle Guske II contributed to this report.
Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, sector or theme.