Cell towers like this one are what power the cell phones we use every day. Image: J. Smith via Wikimedia Commons.
Telecommunications has been a high demand business for decades, and there have traditionally been relatively few companies capable of offering the reliable services people demand. The business has moved from land lines to wireless technology, but the basic industry commodity was a large telecommunications infrastructure that could attract a large number of subscribers. The better your infrastructure, the better your returns.
With that model in mind, there are only two or three stocks that stand out as highly undervalued in today's market.
The undervalued stocks in telecom
When you talk about telecom stocks, the most stable market in the world is in the U.S. And here there are really only four major players: Verizon (VZ 0.49%), AT&T (T +0.47%), Sprint (S +0.00%), and T-Mobile (TMUS +0.28%). But two of those providers -- T-Mobile and Sprint -- are locked in a price war that keeps margins low and the companies unprofitable.
AT&T and Verizon, on the other hand, are highly profitable, and even though those profits can be volatile quarter to quarter I think the profitable trend will continue for many years to come. What these two companies have created is a network so vast that Sprint and T-Mobile don't have the capital to compete. Instead, they're forced to compete on price with the inferior networks they own.
VZ Net Income (TTM) data by YCharts
The lead in infrastructure gives Verizon and AT&T the ability to charge higher prices than competitors, which results in long-term profits for investors, some of which can be invested back in an improving network. From a valuation perspective, they're both cheap as well.
Verizon is currently trading at 12.5 times forward earnings estimates and pays a 4.4% dividend yield, more than double that of Treasuries. AT&T trades for 13.5 times forward earnings and yields a whopping 5.6%. But they're not the only values in telecom today.
The iPhone doesn't become the success it is today without Verizon, AT&T, and American Tower. Image: Apple.
The towers that make it all happen
More than likely, you've had an interaction with my third undervalued telecom stock -- American Tower Corporation (AMT +2.26%) -- without even knowing it. The company owns the towers that Verizon, AT&T, and others put cellular communication equipment on, charging rent for the space they provide.
Towers are a costly component to building a cellular network, and it's more cost effective to share tower space with other providers, or other technologies. This was evident with Verizon's $5 billion tower sale to American Tower earlier this year, which allowed the latter to market tower space to other providers, making more money than Verizon could have alone.
Given the long-term leases for tower space and the capital-intensive nature of building towers, I think American Tower's forward P/E ratio of 16.7 and dividend yield of 1.8% is still undervalued in today's market, and the stock will be a solid investment no matter where the market goes in the next year or two.
The steady state of telecom
One big advantage the telecom industry has over many others is that it's a must-have, whether the economy is good or bad. After six years of a bull market and an economic recovery that's spanned the same timeframe, it's good to own stocks that are staples for consumers because they'll hold up well in a correction.
Against that backdrop, I think Verizon, AT&T, and American Tower are undervalued stocks and will outperform the market long-term.
