ETF Teardown: The Best Wireless Stocks

Noted for their simplicity and other advantages over mutual funds, exchange-traded funds have become a popular investing tool. ETFs hold a collection of stocks that share certain elements in common, so if investors want to capitalize on the rapid proliferation of wireless technologies around the world, for example, they can turn to Wireless HOLDRs (AMEX:WMH), which holds significant stakes in wireless giants such as Motorola (NYSE:MOT) and Qualcomm (NASDAQ:QCOM).

But since this ETF invests in a number of stocks, it gives investors a broad diversity that also limits your upside. For an investor who was, say, really hip to device manufacturers but cold on wireless service providers, this ETF wouldn't fit the bill.

Fear not, Fool -- in this edition of "ETF Teardown," we'll use some nifty tools to drill into the best of what the wireless sector has to offer. To help, we'll use Motley Fool CAPS, our tool for screening and ranking stocks and stock pickers.

The power of tags
To help investors quickly locate great stocks, any of the 4,700 rated stocks that are profiled in CAPS can be "tagged" with a descriptor that groups the company with others that share a certain quality.

Selecting the "Wireless Communications" tag in CAPS presents a list of almost 70 wireless investments that trade on American exchanges. This particular collection of investments has done very well in the past year, up 56% vs. even a spectacular gain of 18% from the S&P.

To get a sense of which companies the CAPS community thinks are the best opportunities in wireless today, we can sort this list by their CAPS star rank, denoted by one to five stars, with five being the best. Each of the individual companies can then be viewed for exactly who -- from Wall Street to Main Street -- is bullish or bearish on the company and why.

Getting down to the nitty-gritty
Here's a sampling of some of the five-star wireless stocks our screen pulled up today.

Many wireless communications company have experienced a boom in business the past few years following the telecom meltdown of 2000, so it's not too difficult to find wireless stocks that have plumped up with increased sales and earnings. But high valuations now accompany many wireless wonders, so it helps to know just why investors are pricing many companies at a premium in this sector.

Wireless technology licensor and Motley Fool Stock Advisor pick InterDigital Communications has earned its five-star CAPS rating by landing big licensing deals with major equipment manufacturers such as Nokia. While licensing revenue can be erratic and unpredictable -- thus making the company difficult to value -- the company still shows a nice PEG ratio of 0.56 returned in a recent screen run for mid caps. The strong cash flow and outlook for increased revenues as more companies contribute ongoing royalties to the company is also reason 185 of the 187 CAPS All-Stars giving an opinion on InterDigital expect it to beat the market going forward.

Recent IPO Aruba Networks has also captivated the CAPS investment community with its wireless enterprise solutions. The company is rapidly growing revenues and is biting at the heels of a much larger competitor in the space, Cisco (NASDAQ:CSCO). While the company is not yet profitable, rapid growth from widespread acceptance of its products has almost doubled gross profit at the firm in the most recent quarter. This growth and excess of $100 million on the balance sheet still left from the IPO has some investors believing the company can scale to reach profitability soon or be bought out by a larger competitor in the enterprise space. Positive feelings about Aruba are reflected in the fact that 94% of investors rating the company in CAPS give it the thumbs-up to beat the market going forward.

Another wireless stock gracing the five-star ranks is Israeli mobile communications service provider Partner Communications. The company holds a 32% share of the mobile market in Israel, which is completely saturated with more cell phone subscriptions than people in the country. The company's increasing cash flow and dividend coupled with a reasonable P/E of 14 have many CAPS investors snapping the stock up from the bargain bin. Indeed, nearly 98% of CAPS All-Stars think this Israeli outfit has the right stuff to be a market-beater in the future.

You can lead a horse to water...
Plucking individual stocks from a diverse sector such as wireless communications is, of course, a high-risk endeavor. Investors should always perform their own due diligence on companies rather than take a recommendation. After all, even the best stock pickers can be horribly wrong on a stock.

So, do you agree wireless equipment makers are the best places to invest? Or are the service providers a better play? Give your own opinion in Motley Fool CAPS.

InterDigital's growth prospects and intellectual property moat helped it make the grade as a Motley Fool Stock Advisor recommendation. Check out what other stocks have helped the average Stock Advisor selection beat the S&P by 37% with a free 30-day trial.

Fool contributor Dave Mock loves doing the teardown part -- it's the put-back-together part he hates. He owns shares of Qualcomm and Motorola. InterDigital is a Stock Advisor recommendation. Dave is the author of The Qualcomm Equation. The Fool has a disclosure policy.