Telecom Stocks: Fundamentals, Dividends Drive Leading Sector

 Spurred by low interest rates and solid fundamentals, telecommunications led U.S. large-cap sectors in performance this year through September. “Investors have been chasing dividend yields as never before,” says Dan Martino, manager of the Media & Telecommunications Fund. “Telecom stocks offer stable fundamentals and historically high relative dividend yields at a time of uncertainty and low interest rates.

“Investors’ quest for dividend yield via telecoms backed off some in the third quarter as investors’ risk appetite returned to the market, but, with the 10-year Treasury rate around 1.6%, “telecom yields remain very attractive,” he says.

 Telecom stock prices have moved up as the 10-year Treasury rate fell. “Tell me where the 10-year Treasury rate is headed, and I will tell you my outlook on telecom sector equities,” he says. In the telecom portion of the fund, however, Mr. Martino pays as close attention to valuations as yields. “You have to be careful with high-dividend stocks—not all dividends are created equal,” he says, noting that the prices of such high-yielding U.S. phone companies as Verizon and AT&T are now relatively high.

  By contrast, he says, there are better values among such international wireless providers as Vodafone, which owns 45% of Verizon, and China Unicom and such U.S. cable franchises as Comcast and Time Warner. Cable firms offer lower yields but at much cheaper multiples of their cash flows. And instead of paying out the highest dividends, some are rewarding investors by buying back stock. “If you take two companies, one with a 3% yield and another with a 7% yield, you really don’t know much about the companies—until you dig deeper into the fundamentals to see what’s driving their cash flows,” Mr. Martino says. Another attractive telecom area involves companies that own cellphone towers and lease space for wireless antennas, such as American Tower, Crown Castle International, and an Indonesia firm, Protelindo, which account for more than 10% of the fund. “These are real estate companies with long-term contracts providing steady, escalating income,” he says. “They are well positioned to leverage the buildout of wireless.”

Barbell Approach

 While Mr. Martino’s portfolio is fairly concentrated—with a little more than 50 stocks—it goes far beyond telecom. His portfolio is unusually bifurcated— with roughly half in these relatively stable global telecom investments and half in more growth-oriented and potentially volatile media and technology stocks. The latter ranges from such well-known U.S.-based firms as Apple, Google, and Qualcomm to Chinese online media companies Baidu, Sina, and Tencent Holdings, which make up more than 9% of the fund.

The connection between the portfolio’s two strategies? “We spend a lot of time thinking about infrastructure, understanding the companies building it, and focusing on the innovations taking place atop the infrastructure,” he says. “The most important trend—the growth of wired and wireless broadband—is driving opportunities. We go anywhere on the growth-value spectrum and in the world to leverage what we see in telecom.”

Mr. Martino notes, for example, that while U.S. smartphone penetration has reached about 60%, it’s only about 10% in China. Similarly, only 20% of advertising has yet to shift to the Internet, but that is growing rapidly each year. “Broadband buildout is a tailwind driving so much innovation, market disruption, and investment opportunities,”he says, “in e-commerce, travel, recruiting, and advertising—almost every area. This is a historically unprecedented time, and it’s going to provide interesting opportunities for a long time.”

To keep up, along with relying on the firm’s fundamental research analysis, Mr. Martino also regularly convenes panels of college students to check out how they’re using media. “They’re on the bleeding edge for trends that will become mainstream,” he says. “I’m not all that much older, and it’s amazing to me how dramatically different their media use is. They’re always connected. TV isn’t that important. They can’t live without their smartphones.”

 Due to its concentration on specific industries and exposures to mid-cap stocks and foreign securities, the Media & Telecommunications Fund’s share price could be more volatile than that of a fund with a broader investment mandate. As of September 30, 2012, stocks mentioned by Mr. Martino made up 58.1% of fund assets.

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