5 Best Communication Services Stocks to Buy for 2021
The best communication services stocks for the coming year have a high bar to clear if they hope to exceed their 2020 outperformance.
Americans were forced to adopt a more virtual life in 2020, and this shift in behavior has boosted already growing demand for services ranging from broadband connectivity, wireless telecommunications and video streaming to food delivery and social networks, among others. These practices are expected to stay (and grow), and that's is great news for the market's best communication stocks.
The S&P 500 Communication Services sector has easily outperformed the broader index in 2020, boasting a total return (price plus dividends) of 19.5% through Nov. 16, versus 14.1% for the broader market. But there's potentially more upside to come in 2021.
The sector's media and entertainment companies are expected to find their footing as advertising revenues recover. Meanwhile, video streaming services are getting a lift from rising consumption at home. As for cable and phone companies, cord-cutting might continue to rise, but consumers still need a fast internet connection. That means fixed and wireless broadband providers are a good play because of their wide moat – setting up a communications network is prohibitively expensive and time-consuming.
"The stay-at-home phenomenon and shift to a remote workforce amid the Covid-19 lockdown could foster some lasting changes in consumer behavior that could provide some tailwinds for broadband consumption," CFRA analyst Tuna Amobi says in a recent research note. Just be aware of the risks, too: "A global slowdown due to the pandemic could exacerbate some liquidity challenges, while a potential recovery could be significantly delayed amid a surge in Covid-19 cases."
Read on as we explore five of the best communication services stocks to buy for 2021.
Data is as of Nov. 17. Dividend yields are calculated by annualizing the most recent payout and dividing by the share price. Free cash flow data provided by Morningstar.
Verizon
- Market value: $251.4 billion
- Dividend yield: 4.1%
- Free cash flow (trailing 12 months): $19.1 billion
Verizon (VZ, $60.75) is a U.S. wireless telecom juggernaut, enjoying an estimated 40% market share in the postpaid (monthly billed) phone business, the most valuable part of a carrier's operations. That share is about a third higher than AT&T's (T) and double that of T-Mobile US's (TMUS).
While the marketplace for mobile phones is quite competitive, when it comes to wireless carriers, there are only three to choose from in the U.S. that offer national coverage. (Other brands typically lease network capacity from the Big Three, and also use Wi-Fi networks.)
Verizon stands above AT&T and T-Mobile because it is laser-focused on providing the largest (and often rated the best) network for users. While it has dabbled in content, the company typically doesn't stray far from its core competencies.
Consider that Verizon's 5G was the clear winner in the most recent US RootScore Awards measuring telecommunications service across the U.S., scoring highest in reliability, accessibility, data and call categories. And while Verizon's 5G network isn't yet as widespread as its competitors, it's the fastest by a mile, showing a 254.7 Mbps download speed at its peak compared to 116.2 Mbps for second-place AT&T.
Meanwhile, in the midst of a pandemic, Verizon still has generated strong free cash flow of $18.3 billion through three quarters, up $3.9 billion year-over-year. And it shares that cash with shareholders via a dividend yielding a healthy 4%-plus. That total-return threat gives VZ the potential to be one of the best communication services stocks of 2021.
Comcast
- Market value: $227.8 billion
- Dividend yield: 1.9%
- Free cash flow (TTM): $13.7 billion
When it comes to the residential broadband market, Comcast (CMCSA, $49.78) leads the way. Its cable-broadband network covers about half of the country – and that lead seems probable to persist because it would take many years and many billions to build something comparable. Google Fiber tried to enter the cable-TV-broadband market but fizzled out.
Comcast also is the biggest diversified media-and-infrastructure company in the U.S., with its NBCUniversal division, which includes the NBC broadcast network, TV stations, cable channels, movie studios, and theme parks.
While NBCUniversal has faced challenges as advertising weakened and people stayed away from movies and theme parks during COVID, look for business to improve in the coming year. It helps that Comcast is diversified geographically as the owner of Sky, Europe's largest media, entertainment and satellite TV company. Acquiring Sky was Comcast's first major international play.
Cord-cutting is a concern for its core cable business, but Comcast is offsetting the decline by gaining broadband customers. And until 5G becomes ubiquitous – enough spectrum has to be cleared first and most phones have to be 5G enabled – there is no practical replacement for home broadband. Comcast has said that more than 75% of customers get 100 Mbps or higher in broadband speeds while 90% have access to its Gigabit service.
In the meantime, Comcast's operations continue to generate more cash: $13.7 billion in the trailing 12 months compares to $13.3 billion in 2019, $12.6 billion in the year before, and $10.1 billion in 2017. Another potential catalyst: Activist investor Trian Fund Management believes Comcast's shares are undervalued and is in talks with the company to make improvements and lift the stock, according to The Wall Street Journal. Trian owns about 0.4% of Comcast. Look for some upside to come with Trian's involvement.
Wall Street currently appears to be undervaluing this communication stock, too, pricing CMCSA shares at just 15.8 times earnings, versus a 25.6 forward price-to-earnings (P/E) for the S&P 500.
Walt Disney
- Market value: $261.1 billion
- Dividend yield: N/A
- Free cash flow (TTM): $3.1 billion
In a short amount of time, Walt Disney's (DIS, $144.50) streaming services are catching up fast to Netflix (NFLX) and Amazon.com's (AMZN) Prime Video.
Amid a tough year for movies and theme parks, Disney has been able to pivot with its Disney+ offering. Disney+ has already signed up 73 million paying subscribers as of October, which puts it within its range of the 60 million to 90 million goal it set for 2024. Soon, it plans to launch a global streaming service under its Indian unit's Hotstar brand.
Disney also has a controlling stake in Hulu, for a combined audience of about 110 million paying subscribers.
Activist investor Daniel Loeb of Third Point Capital wants Disney to capitalize on its hot streak in streaming. He also wants Disney to stop paying its $3 billion yearly dividend (DIS suspended its first-half payout earlier this year) and instead use that money to double the programming budget for streaming.
Disney has suffered through the economic slump of 2020. But look for it to become one of the best communication services stocks for 2021, given the potential for its financials to rebound as advertising recovers and people return to theaters and theme parks.
And remember: Disney is the content king, having solidified its status with the 2019 acquisition of 21st Century Fox to join its Pixar, Marvel and Star Wars franchises. Whether people cut the cord or stay with their cable company, they will always want good content.
"Disney has mastered the process of monetizing its world-renowned characters and franchises across multiple platforms," says Morningstar analyst Neil Macker in a recent note. "The company has moved beyond the historical view of a brand that children recognize and parents trust by acquiring and creating new franchises and intellectual property."
"Disney uses the success of its filmed entertainment not only to drive Disney+ subscriptions, but also to create new experiences at its parks and resorts, merchandising, TV programming, and even Broadway shows. Each new franchise deepens the Disney library, which should continue to generate value over the years," he adds.
Alphabet
- Market value: $1.2 trillion
- Dividend yield: N/A
- Free cash flow (TTM): $34.0 billion
It is a testament to the strength of Google parent Alphabet (GOOGL, $1,761.66) that its stock continued to rise after the U.S. Justice Department announced an antitrust lawsuit against the search giant. Just as undeterred is the analyst community, where 40 of 44 pros rating the stock call it a Buy.
Morningstar analyst Ali Mogharabi, who places a fair value of $1,980 per share on the stock, believes a breakup of the company is unlikely. Rather, he thinks Alphabet will be fined, similar to what happened in Europe, where it was assessed $10 billion.
However, "even if regulators ultimately succeed in forcing a breakup, we believe Alphabet is at least as valuable based on the sum of its individual parts as it is whole," Mogharabi says.
The company is attractive in the long run due to its wide moat. Google has an 80% market share in global online search. It also benefits from a strong "network effect" in which as more people join its ecosystem, the more valuable it becomes. For example, the more people use the Google search engine, the more attractive and precise its advertising services become.
Google's other lines of business – YouTube, Android, Gmail, DoubleClick, Waze and Maps, among them – have a vast reach as well.
Mogharabi also lauded Google for its impressive third-quarter results, which featured stronger ad revenue and double-digit growth in cloud services. "As the economy recovers, we expect digital ad spending to accelerate, from which Google will be one of the main beneficiaries," he says.
Alphabet boasts a 20.8% annualized earnings growth rate over the past three years. According to S&P Global Market Intelligence, analysts expect long-term growth (three to five years) of about 16.4% annually – not as robust, but still a healthy clip for a trillion-dollar company.
AT&T
- Market value: $206.9 billion
- Dividend yield: 7.2%
- Free cash flow (TTM): $28.2 billion
AT&T (T, $29.03) is trying to turn a corner from its struggles following the acquisition of DirecTV and Time Warner, so look for upside to come in 2021. If its third-quarter performance is any indication – strong wireless growth, broadband rebounding and video losses narrowing – the telecom company is perhaps finally finding its footing as the economy improves.
Morningstar analyst Michael Hodel believes the stock is trading at a discount and its fair value is $37. Despite the company's ill-advised capital allocation decisions, "we believe AT&T's most important segments (wireless and media) are solid businesses on their own."
Hodel says that AT&T's scale in wireless is an advantage; it owns deep network infrastructure across much of the U.S. Also, T-Mobile's merger with Sprint "greatly improved the industry's structure, leaving three players with little incentive to price irrationally in search of short-term market share gains." In other words, there's less chance for big discounts as they compete – not great for consumers, but good for the telecom providers.
Meanwhile, WarnerMedia remains a "media powerhouse with a deep content library and the ability to reach audiences across a wide variety of platforms," Hodel says. Despite some concerns about how well AT&T can execute on its video streaming plans, "this position should enable its studios and networks to remain a destination of choice for the best content creators well into the future."
AT&T isn't without its risks, which is somewhat telegraphed via an outsized 7%-plus yield. Among those risks is $178 billion in net debt (debt minus cash) – one of the largest piles of IOUs on Wall Street.
But despite heavy capital expenditures and interest payments, the company still is able to churn out massive cash flows, which have come to $28.2 billion over the past 12 months. It might not provide breakneck growth like some of its sectormates, but the large dividend still can help AT&T be one of the most productive communication services stocks of 2021.
