After the industrywide stock classification system was reorganized, a new sector was created: communication services. It was formed by combining the former telecommunication services sector with media stocks from the consumer discretionary sector, as well as internet software and services stocks and home entertainment software stocks from the technology sector. Communication services reflects the increasing overlap of the business models of telecom, media and internet companies. This mix of stocks results in a sector that is much more offensive than defensive, meaning that it will likely outperform the overall stock market in rising markets and underperform the overall in down markets. We believe that internet services, digital advertising and wireless services will be key growth drivers for the sector.
Sector is dominated by internet and media stocks
Internet and media stocks that have moved into the sector contribute a significant amount of the sector’s market capitalization. These stocks represent some of the largest companies in the S&P 500 Index.
Advertising is a significant driver for the sector
With the addition of media and internet stocks, the strength of spending on advertising, especially online ad spending, will significantly impact the results for stocks in the sector. Even traditional telecom companies have become more exposed to ad spending due to acquisitions within the media space. Ad spending tends to be directly related to the overall health of the economy. We estimate that the worldwide digital ad market is currently growing at a 16% – 18% annual rate. The two primary formats for digital advertising are search (e.g., Google) and display (e.g., Facebook, Twitter, Amazon, etc.).
New sector offers exposure to emerging online and mobile trends
The formation of the communication services sector reflects the evolution of media and telecom company business models and the emergence of online search, social media and video, which are pulling subscribers away from traditional media, such as newspapers, magazines and broadcast television. As people spend increasing portions of their time on internet-sourced media, advertisers have shifted their ad dollars to online and mobile sources of content. These forms of online advertising are broadly labeled the digital advertising market.
What this means to investors
Investors with diversified-equity portfolios may want to consider allocating a portion of their portfolios to the communication services sector. Consider looking at dividend yields, interest rate sensitivity and individual performance compared to the overall equity market. Talking with a financial advisor can help you determine what choices in the communication services sector may be the right fit for your investment portfolio.
Investing in equities involves risks. The value of your shares will fluctuate, and you may lose principal.