Photo by Austin Distel on Unsplash
 

In 2018, the General Industry Classification System (GICS) that defines the sector and industry groups of the S&P 500 made major changes to better reflect the changing global stock market environment. The primary change was the creation of the Communications Services sector and the elimination of a separate Telecommunications Services Sector. 

The new sector includes all the companies that were in Telecommunications and added many important companies from the Consumer Discretionary and Information Technology (IT) sectors. In fact, since GICS sectors are market-cap weighted, at the time the reformulation was implemented, IT immediately became 55% of the new sector’s weight, more than 80% of which came from Alphabet and Facebook (now Meta). Indeed, part of the motivation for the reformulation was to reduce the huge overweighting of the major indexes in the GICS IT sector.   

State Street Global Advisors (SSgA), the parent company of SPDRs ETFs, has a family of ETFs representing each GICS sector called Select Sector SPDRs (pronounced Spiders). In synchrony with the reformulation, SSgA quickly created a new Select Sector SPDR, XLC, to represent the Communications Services Sector.

Why did I decide to publish an article about the sector coinciding with its fourth anniversary? The dichotomy between the new Communications Services and the former Telecommunications Services sectors struck me as earnings reports started coming in this quarter.  Meta, META, the largest position in XLC, announced disappointing earnings and revised guidance downward. The stock fell by more than 10% in two days. Conversely, AT&T, T, the largest stock of the former Telecommunications sector significantly beat the consensus analyst EPS target. Moreover, the CEO indicated that subsequent increases in revenues were expected. This led me to investigate whether a changing of the guard was happening in the sector where the telecommunications-focused communication companies would usurp leadership from the IT-focused communication reports. 

This report focuses on comparing the stocks of two IT-focused companies in the sector, META and videogame giant Activision Blizzard (ATVI) alongside the two largest traditional telecommunications companies T and T-Mobile US (TMUS). Both are compared to XLC and the original SPDR (SPY) representing the S&P 500 Index.

The table below provides summary info for the four stocks and two ETFs. All data are as of Oct. 21, 2022. More comprehensive analysis can be found by pulling up the underlying ValuEngine reports.

_{* ETF Undervaluation # is the percentage of undervalued stocks, not a comparison with all other ETFs in our universe}
 

Analysis 

1. The two telecommunication companies, AT&T (T) and T-Mobile US (TMUS) have had more positive price changes for the period for the past 1-, 3-,6-, and 12-month time frames than XLC, the Sector ETF.  With higher returns than all the non-telecom stocks and both ETFs in all the periods measured during the past 5 years, TMUS has been a superior stock to own for a long time. It has by far the highest Sharpe Ratio, a measure of return-per-unit-risk, of 0.75 compared to 0.11 for XLC. However, TMUS is rated just 3 (hold) to perform in line with the market during the next three-to-twelve months. 

2. XLC has considerably underperformed SPY which tracks the S&P 500 Index in all of the measured periods. The chief culprit is META Platforms (META), the parent of Facebook and at 12.8%, the largest single weight in XLC.  Its woes in the past 12 months have been well publicized. It has more than 2/3 of its value during the past 12 months taking it from more than 20% of this ETF to its current weight. The one bright spot for META now is its current valuation. It has gone from a stock that was extremely overvalued according to the traditional ratios, Price/Earnings, Price/Book, and Price/Sales to one with below-market valuations in all three. Moreover, the ValuEngine (VE) valuation model has it in the 85^th percentile meaning it is more undervalued than 85% of the stocks in our universe of companies.
3. Valuation is also a highlight for the company whose name is synonymous with old-line telecommunications, AT&T (T).  For a “fallen angel” with a positive earnings surprise in its last report and positive guidance, T is stunningly attractive from the perspective of the 4 conventional value ratios. It is selling below book value, at par with sales per share, and at a price/earnings ratio about 1/3 of that of SPY. It also has an extremely attractive dividend yield of 6%. The VE valuation model has it in the 62^nd percentile, more undervalued than 62% of the stocks in the VE universe. The market noticed the earnings turnaround. During the past month, its price has risen 16.7% as compared to -1.3% for sector ETF XLC and +5.0% for SPY.  However, the VE rating for attractiveness is unimpressed thus far, actually lowering its rating recently from a 2 (sell) to a 1 (strong sell). It is the only stock rated so low in the study. Since our ratings incorporate future earnings estimates, it is possible that the estimates one year out have not been revised upward enough by analysts to justify recent price gains.  Some analysts may be awaiting confirmation.  
4. Alternatively, both non-telecommunication companies, META, formerly in the Information Technology sector, and Activision Blizzard (ATVI), formerly in the Consumer Discretionary sector rated 4 (buy) by the VE model. They have an identical 1-year price target of +7.96%. On a valuation basis, ATVI is overvalued relative to XLC and the other stocks both in terms of the traditional ratios and by the ValuEngine valuation model ranking in the 34^th percentile.  This is partial because ATVI has outperformed
5. Four years after its introduction as a new GICS Sector, Communications Services are very heterogeneous. This is also true of the 25 companies from the S&P 500 comprising XLC. Some sectors, such as Energy and Transportation, tend to have most of the company stocks rising or falling in lockstep during pronounced trends. This has certainly not been true of the stocks contained within XLC.
    

Conclusion

This has been a very volatile year for the stock market and these stocks have not been an exception. During that volatility, TMUS, the least volatile stock in the sample, held up quite well throughout the year while T, the second least volatile, has come back impressively in the past 4 weeks. Our prediction model warns against looking backward and prefers META and ATVI to bounce back strongly in the next 12 months relative to the market. 

At the same time, our valuation model also likes META best and T as the second most undervalued. Despite the run-up, T still looks attractive on a valuation basis. Perhaps our VE price-appreciation-prediction model is not yet convinced that the upward revisions in earnings are real. It may be awaiting a second positive report for confirmation. Value strategists might argue that waiting for confirmation is a good way to miss out on potential profits but our model disagrees.

On the other hand, almost all of the analysts and portfolio managers I’ve seen or read are still very negative on META’s prospects.  Both our valuation model and our price appreciation model indicate that it may be time to take a fresh look at it.  

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