Exchange-traded funds offer a convenient way to invest in sectors or niches that interest you. If you'd like to add some networking companies to your portfolio but don't have the time or expertise to hand-pick a few, the iShares North American Tech-Multimedia Networking ETF (NYSEMKT:IGN) could save you a lot of trouble. Instead of trying to figure out which stocks will perform best, you can use this exchange-traded fund to invest in lots of networking companies simultaneously.
Why this ETF, and why networking companies?
As our world gets more and more connected, demand for networking products and services will grow. Developing economies are likely to drive the most demand, but analysts at Zacks have noted that close to a fifth of America is still without broadband access. New and growing technologies will boost demand further -- think cloud computing, big data, smartphones, high-speed fiber networks, and more.
This ETF charges an annual fee of 0.48%. It has underperformed the world market in the past decade but is ahead of it year to date. It's the future that counts, though, and the past poor performance is partly due to major holdings that have tanked.
A closer look at some components
On your own you might not have selected Finisar Corporation (NASDAQ:FNSR) or ARRIS Group, (NASDAQ:ARRS) as networking companies for your portfolio, but this ETF included them among its more-than-20 holdings.
Optical telecommunications equipment specialist Finisar has been on a bumpy ride lately, with its fortunes significantly tied to those of its key customers, such as Cisco Systems. The company has been posting annualized revenue growth of 15% over the past five years, but earnings and free cash flow have been unstable and occasionally negative. The company's last earnings report sent shares down by more than 20%, as it revealed a big drop in gross profit margins coupled with gloomy management forecasts for the next quarter. Still, revenue surged 26%, topping Wall Street estimates, and while earnings missed estimates, they still rose by 80%.
The lower margins owe to the company's selling more low-margin products in an effort to drum up more business in China. Lower margins are not great news, but they can be made up for by greater volume, and China does offer much potential. Finisar also boasts a broad portfolio with a range of products serving datacom and telecom aplications, which enables it to profit from the success of many new technologies and not have too many eggs in one basket. In its last quarter, sales of telecom products flagged a bit but were more than offset by a big gain in datacom equipment sales. The stock is heavily shorted, meaning that many are betting against it, but if they're wrong, then bulls stand to gain even more.
With a recent P/E around 23 and a forward P/E near 14, Finisar seems appealingly priced, especially considering its growth rate and prospects. Some are drawn to the stock because of speculation that it might be bought out, perhaps by Cisco Systems, but speculation isn't a great reason to buy a stock. Focus instead on the company's health and prospects – and in those departments, Finisar is doing rather well, experiencing strong demand for its offerings and expecting more, as data centers proliferate and its new products start selling.
ARRIS Group acquired Motorola Home last year and is in the business of offering video and broadband technology to cable system operators via set-top boxes, among other things. Its first-quarter results were strong, featuring estimate-topping revenue and earnings, its order backlog nearly doubling to $1 billion, and management significantly increasing its projections. Unit volume for set-top boxes grew 11% over year-ago levels, while broadband-related equipment gained 20%.
The fact that cable companies are competing aggressively with each other bodes well for ARRIS, as they can use new and fancier set-top boxes to differentiate themselves. ARRIS is also well positioned in the Internet Protocol TV (IPTV) arena, too, already having relationships with major pay-TV services. Management says it's spending more on R&D than competitors; that's good news, because in a fast-changing arena such as networking, companies frequently need to roll out newer, better offerings.
ARRIS stock has more than doubled over the past year and has averaged annual gains of 20% over the past decade. Its forward P/E ratio is still only around 11.5, though, and with a favorable valuation relative to competitors and ample free cash flow, ARRIS is an appealing candidate for a portfolio.
The big picture
It makes sense to consider adding some networking companies to your portfolio. You can do so easily via an ETF. Alternatively, you might simply investigate its holdings and then cherry-pick from among them after doing some research on your own.