* All data are as of the close of Wednesday, November 26, 2014. Emphasis is on company fundamentals and financial data rather than commentary.
The Communication Equipment industry has been having a rough go of it despite the surge in tech-related business activity during the economic recovery. Investors need to consider the difference in the types of products and services the industry offers.
In the simplest of descriptions:
"Companies in the Communication Equipment category focus on manufacturing and selling communications equipment, software, and products including LANs, WANs, routers and telephones. This sector does not include manufacturers that sell phones and accessories to individuals."
Hence, when investing in companies that belong to the Communication Equipment industry, we aren't investing in the smartphone market that has been so hot during the recovery. What we're investing in here is the more mundane corporate, institutional and government communications services.
The top three U.S. companies in the space offer the following:
• Qualcomm Incorporated (NASDAQ: QCOM), headquartered in San Diego, California, offers integrated circuits and system software, orthogonal frequency division multiple access, and other technologies using voice and data communications, networking, application processing, multimedia, and global positioning system products. It also grants licenses or rights to use portions of its intellectual property.
• Motorola Solutions, Inc. (NYSE: MSI), headquartered in Schaumburg, Illinois, provides mission-critical communication infrastructure, devices, software, and services for government, public safety, and commercial customers, encompassing network infrastructure, devices, system software, and applications for the public safety, hospitality, education, manufacturing, transportation, utilities, mining, and retail industries, including computer-aided dispatch, records systems, data management systems, and real time crime center solutions.
• Harris Corporation (NYSE: HRS), headquartered in Melbourne, Florida, offers secure tactical radio communications and high-grade encryption solutions for military, government, and commercial customers, as well as secure communications systems and equipment for public safety, utility, and transportation customers, which encompass a line of secure radio communications products and systems for manpack, handheld, vehicular, airborne, strategic fixed-site, and shipboard installations, which include assured communications systems and equipment utilizing Internet protocol based voice and data communications systems used by public safety, federal, utility, commercial, and transportation organizations, as well as multiband radios comprising a handheld radio and a full-spectrum mobile radio for vehicles.
Since their businesses are not as driven by consumerism as other technology companies are, they tend to behave a little more conservatively, falling less in bear markets and rising less during bulls, as graphed below.
During the market downturn from June 2007 to March 2009, where the broader market S&P 500 index [black] fell 56% and the Technology Select Sector SPDR ETF (NYSE: XLK) [blue] fell 50%, Qualcomm [beige] and Harris [orange] both fell less, some 22% and 39%, respectively, while only Motorola [purple] fell more at 83%.
During the recovery since then, the companies have put in a reciprocal performance. Where the S&P has risen some 205% and the XLK has risen 220%, Qualcomm and Harris have risen less at 120% and 139%, respectively, while Motorola has risen a stunning 415%.
On an annualized basis, where the S&P has averaged 36.18% and XLK has averaged 38.82%, Qualcomm has averaged 21.18%, Harris has averaged 24.53%, while Motorola has averaged 73.24% per year!
Looking forward, the industry as a whole is expected to outperform the broader market in earnings growth as tabled below, where green indicates outperformance, while yellow denotes underperformance.
While immediate term growth rates are not available, 2015 is expected to see the industry grow at some 2.09 times the S&P's average earnings growth rate, before settling to a more sustainable, but still robust 1.64 times over the next five years.
Zooming-in a little closer, the three largest U.S. companies in the industry are expected to struggle over the immediate term as tabled below, with all three companies suffering earnings shrinkage in the current quarter, and Motorola being the only one to outperform the market next quarter and in 2015.
Over the longer term, however, Qualcomm is seen outperforming all, including Motorola, which itself slips into underperformance.
Yet there is more than earnings growth to consider when sizing up a company as a potential investment. How do the three compare against one another in other metrics, and which makes the best investment?
Let's answer that by comparing their company fundamentals using the following format: a) financial comparisons, b) estimates and analyst recommendations, and c) rankings with accompanying data table. As we compare each metric, the best performing company will be shaded green while the worst performing will be shaded yellow, which will later be tallied for the final ranking.
A) Financial Comparisons
• Market Capitalization: While company size does not necessarily imply an advantage and is thus not ranked, it is important as a denominator against which other financial data will be compared for ranking.
• Growth: Since revenues and expenses can vary greatly from one season to another, growth is measured on a year-over-year quarterly basis, where Q1 of this year is compared to Q1 of the previous year, for example.
In the most recently reported quarter, Qualcomm posted the greatest revenue and earnings growth year-over-year, while Motorola contended with the lowest growth, even reporting revenue and earnings shrinkage along with Harris.
• Profitability: A company's margins are important in determining how much profit the company generates from its sales. Operating margin indicates the percentage earned after operating costs, such as labor, materials, and overhead. Profit margin indicates the profit left over after operating costs plus all other costs, including debt, interest, taxes and depreciation.
Of our three contestants, Qualcomm operated with the widest profit and operating margins, while Harris and Motorola split the narrowest margins between them.
• Management Effectiveness: Shareholders are keenly interested in management's ability to do more with what has been given to it. Management's effectiveness is measured by the returns generated from the assets under its control, and from the equity invested into the company by shareholders.
For their managerial performance, Harris' management team delivered the greatest returns on assets and equity, while Motorola's team delivered the least.
• Earnings Per Share: Of all the metrics measuring a company's income, earnings per share is probably the most meaningful to shareholders, as this represents the value that the company is adding to each share outstanding. Since the number of shares outstanding varies from company to company, I prefer to convert EPS into a percentage of the current stock price to better determine where an investment could gain the most value.
Of the three companies here compared, Motorola provides common stock holders with the greatest diluted earnings per share gain as a percentage of its current share price, while Qualcomm's DEPS over current stock price is lowest.
• Share Price Value: Even if a company outperforms its peers on all the above metrics, however, investors may still shy away from its stock if its price is already trading too high. This is where the stock price relative to forward earnings and company book value come under scrutiny, as well as the stock price relative to earnings relative to earnings growth, known as the PEG ratio. Lower ratios indicate the stock price is currently trading at a cheaper price than its peers, and might thus be a bargain.
Among our three combatants, Qualcomm's stock is the cheapest relative to forward earnings, company book value and 5-year PEG, while Motorola's stock is the most overpriced in all ratios.
B) Estimates and Analyst Recommendations
Of course, no matter how skilled we perceive ourselves to be at gauging a stock's prospects as an investment, we'd be wise to at least consider what professional analysts and the companies themselves are projecting - including estimated future earnings per share and the growth rate of those earnings, stock price targets, and buy/sell recommendations.
• Earnings Estimates: To properly compare estimated future earnings per share across multiple companies, we would need to convert them into a percentage of their stocks' current prices.
Of our three specimens, Qualcomm offers the highest percentages of earnings over current stock price for all time periods, while Harris offers the lowest percentages for the current quarter, and Motorola offers them the rest of the way.
• Earnings Growth: For long-term investors this metric is one of the most important to consider, as it denotes the percentage by which earnings are expected to grow or shrink as compared to earnings from corresponding periods a year prior.
For earnings growth, Qualcomm offers the greatest growth rate in the current quarter and over the next five years, while Motorola offers it next quarter.
Yet it is important to note that all three companies are expected to suffer earnings shrinkage in the current quarter, while Motorola is the only one to not shrink next quarter.
• Price Targets: Like earnings estimates above, a company's stock price targets must also be converted into a percentage of its current price to properly compare multiple companies.
For their high, mean and low price targets over the coming 12 months, analysts believe Qualcomm's stock offers the greatest upside potential and greatest downside risk, while Harris' stock reciprocates with the least upside and least downside.
• Buy/Sell Recommendations: After all is said and done, perhaps the one gauge that sums it all up are analyst recommendations. These have been converted into the percentage of analysts recommending each level. However, I factor only the strong buy and buy recommendations into the ranking. Hold, underperform and sell recommendations are not ranked since they are determined after determining the winners of the strong buy and buy categories, and would only be negating those winners of their duly earned titles.
Of our three contenders, Qualcomm is best recommended with 9 strong buys and 17 buys representing a combined 68.42% of its 38 analysts, followed by Motorola with 1 strong buy and 2 buy recommendations representing 15.79% of its 19 analysts, and lastly by Harris with no strong buy and 1 buy rating representing 12.50% of its 8 analysts.
Having crunched all the numbers and compared all the projections, the time has come to tally up the wins and losses and rank our three competitors against one another.
In the table below you will find all of the data considered above plus a few others not reviewed. Here is where using a company's market cap as a denominator comes into play, as much of the data in the table has been converted into a percentage of market cap for a fair comparison.
The first and last placed companies are shaded. We then add together each company's finishes to determine its overall ranking, with first place finishes counting as merits while last place finishes count as demerits.
And the winner is… Qualcomm with a loud-and-clear over-and-out victory, outperforming in 21 metrics and underperforming in 4 for a net score of +17, followed far behind by Harris, outperforming in 6 metrics and underperforming in 9 for a net score of -3, with Motorola all broken up by static in the far distance, outperforming in 4 metrics and underperforming in 18 for a net score of -14.
Where the Communication Equipment industry is expected to outperform the S&P broader market significantly in 2015 and moderately beyond, the three largest U.S. companies in the space are expected to struggle over the immediate term as all three suffer earnings shrinkage in the current quarter, with Motorola being the only one to outperform next quarter and 2015, and Qualcomm being the sole outperformer over the longer term.
Yet after taking all company fundamentals into account, Qualcomm sends the strongest and clearest signal to investors given its lowest stock price ratios, lowest debt over market cap, highest current ratio, highest trailing revenue and earnings growth, widest profit and operating margins, highest EBITDA over revenue, highest future earnings over current stock price in all time periods, highest future earnings growth in the current quarter and next five years, best high and mean price targets, and most strong buy and buy analyst recommendations - decisively winning the Communication Equipment industry competition.