The Telecom Services sector ranks sixth 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 14 mutual funds in the Telecom Services sector as of April 8, 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 17 to 64), 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.
Figure 1: ETFs with the Best & Worst Ratings
Sources: New Constructs, LLC and company filings
Figure 2: Mutual Funds with the Best & Worst Ratings – Top 5
Sources: New Constructs, LLC and company filings
PFS Funds: Wireless Fund (WIREX) is excluded from Figure 2 because its total net assets (TNA) are below $100 million and do not meet our liquidity standards.
Fidelity MSCI Telecommunications Services Index ETF (FCOM) is my top-rated Telecom Services ETF and Fidelity Select Portfolios: Wireless Portfolio (FWRLX) is my top-rated Telecom Services mutual fund. Both earn my Dangerous rating.
ProShares Ultra Telecommunications ProShares (LTL) is my worst-rated Telecom Services ETF and Rydex Series Funds: Telecommunications Fund (RYTLX) is my worst-rated Telecom Services mutual fund. Both earn my Very Dangerous rating.
Figure 3 shows that 10 out of the 109 stocks (over 19% 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 14 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, as no ETFs and mutual funds in the Telecom Services sector allocate enough value to Attractive-or-better-rated stocks to earn an Attractive rating. Investors should look to individual stocks for exposure to this sector
Neustar Inc. (NSR) is one of my favorite stocks held by Telecom Services ETFs and mutual funds and earns my Very Attractive rating. NSR has grown after-tax profit (NOPAT) by 19% compounded annually since going public in 2005. NSR also earns a top quintile return on invested capital (ROIC) of 15%. However, investors don’t believe in the future of NSR. At ~$29/share, the stock has a price to economic book value (PEBV) ratio of 0.8. This ratio implies that the market expects NSR’s NOPAT to permanently decline by 20%. To believe this, one must think that NSR’s core business will suddenly stop producing. There is no evidence to suggest that such an outcome is likely. NSR is a good company trading at a great price.
United States Cellular Corp (USM) is one of my least favorite stocks held by Telecom Services ETFs and mutual funds and earns my Very Dangerous rating. USM also makes my Most Dangerous Stocks list for April. From 2008-2013, USM’s NOPAT declined from $401 million to -$86 million. By recording gains on their sale of assets, USM was able to mask this loss in 2013, but the company remains in trouble. Despite the long-term profit decline, and abysmal profit drop in 2013, USM is still valued like a profitable company. To justify the current price of ~$41/share, USM would need to earn pre-tax margins of 5% and grow revenues by 10% compounded annually for 16 years. If it achieved this goal, USM would earn an ROIC of 8%, which exceeds the past performance of the company in every year in our model. This expectation means a complete turnaround is already priced in for USM in an industry that is dominated by a few key players, leaving little room for failure. Overly optimistic expectations coupled with the lack of profit growth from USM leave too much downside risk. Investors should avoid USM.
38 stocks of the 3000+ I cover are classified as Telecom Services stocks, but due to style drift, Telecom Services ETFs and mutual funds hold 64 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 14 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.