In 2020, U.S. telecoms rolled out their next-gen 5G networks nationwide. But to take advantage of the better service, consumers will need to upgrade to devices that can connect to 5G. So a new mobile upgrade cycle is under way, one that could last for years, and 5G technology itself is still being developed and improved upon.
1. T-Mobile: The future U.S. telecom leader?
Thanks to its acquisition of Sprint last year, T-Mobile leapfrogged into second position in the U.S. telecom category, trailing behind only Verizon (NYSE:VZ). While Verizon remains my top pick for investors looking for income, I've warmed up to T-Mobile in the emerging 5G era.
Historically, T-Mobile has trailed behind its largest telecom peers technologically, but the recent acquisition was about more than picking up new Sprint subscribers. The company was able to combine its 4G network with Sprint's to strengthen its core service, as well as combine the 5G spectrum Sprint had acquired with its own to make what is (for now) the nation's largest 5G network. In fact, T-Mobile earned first-mover status with its nationwide launch of 5G last year, beating both Verizon and AT&T (NYSE:T) to the punch.
Owing to this fact, T-Mobile is still in growth mode, while Verizon and AT&T have been stuck in a rut. The neon pink mobile giant added a net 2 million subscribers in the third quarter of 2020. T-Mobile is also a simpler operation, one not bogged down by troubled media assets, while Verizon owns scraps of the old AOL and Yahoo! and AT&T owns Warner Media. It's also worth noting that it has far less debt than its competitors -- and thus more financial flexibility.
Of course, investors who own T-Mobile are giving up the chance to earn a dividend in exchange for growth and a nimbler operation. T-Mobile is also more "expensive" than the other two big U.S. telecom stocks, currently trading for 43 times trailing 12-month earnings, versus 19 and 13 times trailing 12-month earnings for Verizon and AT&T, respectively. Nevertheless, T-Mobile is unlocking profitability as it integrates Sprint's assets, and is still growing its customer base at a more-than-respectable pace. Out of the three largest U.S. telecoms, T-Mobile looks like the best long-term bet at this juncture.
2. Applied Materials: New chips means new manufacturing equipment
The 5G rollout is most visible to consumers via the services they get from their telecom providers, but there's a great deal of work going on behind the scenes. New hardware enabling the network itself needs to be built and deployed, and devices that can connect to it need to be updated. It's in this realm where the best investments can be uncovered.
Semiconductor manufacturing equipment provider Applied Materials is a great pick for investors looking for broad-based exposure to the chip industry and related hardware used in building 5G. Applied Materials has a hand in the fabrication of all sorts of tech that's central to 5G-enabled phones and devices, from memory chips to ultra-high-definition OLED screens. Coming out of a cyclical slump in many of its end markets, revenue grew 18% last year to $17.2 billion, a new annual record. In the final quarter of the company's 2020 fiscal year it reported a 25% year-over-year rate of growth, and management forecasted another 19% year-over-year sales increase (at the midpoint of guidance) for Q1 2021.
Given its momentum, Applied Materials stock looks like a reasonable value. It currently trades for just 24 times trailing 12-month free cash flow (revenue minus cash operating expenses and capital expenditures). The sale of manufacturing equipment is highly profitable for Applied Materials, and any incremental addition to revenue has meant an even greater increase in profitability. For example, the 25% increase in revenue at the end of 2020 equated to a 58% increase in free cash flow. An even faster increase in the bottom line is likely in store if Applied Materials can keep its foot on the gas in the year ahead.
Applied Materials is also well-positioned to continue researching new technology and developing new manufacturing processes for its partners. It had $6.5 billion in cash, equivalents, and long-term investments on its books at the end of October 2020, offset by long-term debt of just $5.4 billion. The semiconductor industry is a cyclical one subject to fluctuations in chip supply and demand, but Applied Materials is a great way to invest in the increasingly important role chips play in the world -- 5G included. This could be a big winner in the decade ahead.
3. NVIDIA: An emerging force in the world of mobility?
Speaking of potential big winners in the next decade, NVIDIA tops my list of semiconductor stocks. The company that made its name developing graphics processing units (GPUs) for high-end video game graphics is applying its technology to a long and growing list of other computing needs.
Many of these use cases overlap with or directly participate in the nascent 5G network. Before it gets turned into 5G wireless signal, 5G networks still need to travel via internet infrastructure, data centers, and edge networks (smaller data centers located close to end-users). NVIDIAs chips are being adopted in this area at a rapid pace, and are close to becoming the company's largest sales segment. The 5G rollout will also encompass more than just smartphones, enabling machine-to-machine communications in industrial applications like healthcare and autonomous vehicles. NVIDIA plays a role here as well with its various robotics and AI research divisions.
And then there's the pending acquisition of ARM Holdings -- a transformative move that, among other things, will thrust NVIDIA directly into the mobile industry (since ARM licenses its chip architecture to a wide range of chip designers like Qualcomm). Adding ARM to the mix will immediately open new doors for NVIDIA and build on its already eminent research capabilities. In Q3 2020, NVIDIA's revenue surged 57% higher year over year. Clearly, the company is striking while the iron is hot and maximizing on the massive market opportunity that lies ahead of it.
NVIDIA's impressive run comes at a high price, though: This is the most "expensive" 5G pick on my list here at nearly 80 times trailing 12-month free cash flow. Bear in mind that NVIDIA is foregoing maximum profitability right now, and is instead primarily concerned with growth. A high premium on the stock reflects its heavy investment in the development of new solutions. But for investors looking at the potential a decade or more down the road, I think the price tag is worth paying for this emerging leader in computing and new technology like 5G.