Best Telecom Stocks to Buy in 2022 | The Motley Fool

Telecom companies provide the technology that links our increasingly connected world. Companies in the sector offer phone, internet, and television services, along with the infrastructure to support them.

The telecommunications sector is often attractive to relatively conservative investors seeking dividend income, but plenty of telecom companies are also significantly growing.

Let's take a closer look at some top telecommunications companies and consider what to prioritize when choosing telecom stocks for your portfolio.

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Best telecom stocks

Three companies stand out as telecom industry leaders:

1. Verizon Communications

Verizon Communications (NYSE:VZ) is the largest wireless carrier in the U.S. Its scale produces excellent free cash flow and superior gross margins. Verizon’s cash flow consistently exceeds its dividend payment, which enables the company to maintain an attractive dividend yield. And, with the recurring nature of its revenue, Verizon is unlikely to see a significant drop in cash flow anytime soon.

Verizon’s management has also maintained its debt at manageable levels, unlike many competitors that have relied on leverage to fund acquisitions. The company has a wireline business, but it has been divesting its assets over the past several years to raise cash and expand its wireless business.

Verizon’s capital spending is primarily driven by the acquisition and deployment of wireless spectrum licenses. It was the biggest bidder in the 2021 C-Band spectrum auction, and the company will spend heavily to deploy its licenses to expand its 5G network and catch up with the competition in coverage. With historically strong return on invested capital compared to competitors, investors should look for Verizon to remain higher than other wireless carriers, even if the extra spending leads to a drop in the profitability ratio.

2. Comcast

Comcast (NASDAQ:CMCSA) is the largest pay-TV and home internet service provider in the U.S. Although it also owns NBCUniversal, which is a giant in the media industry, Comcast’s biggest source of revenue and profits is its cable communications business.

Comcast stands out for bringing in hundreds of thousands of new internet subscribers every year. Earning relatively high margins from internet customers has enabled the company to offset its video subscriber losses while still increasing its operating income at a strong rate. Despite increased competition for internet service from wireless carriers, Comcast’s market share should allow it to invest more in its network to maintain the company’s position in the markets where it operates.

Comcast also owns Sky, a dominant pay-TV operator throughout Europe that the company acquired in 2018. Comcast’s NBCUniversal is well positioned to support the continued expansion of Sky on the continent, and Sky enables NBCUniversal to follow through on its plan to launch a direct-to-consumer streaming service in Europe.

Comcast paid a high price for Sky, which added a lot of debt to the company’s balance sheet. But the telecom giant's strong free cash flow and improving margins make it likely that Comcast can reduce its debt to more attractive levels.

A worker standing at the bottom of a telecom tower.

Source: Getty Images

3. American Tower

American Tower (NYSE:AMT) operates more cell towers in the U.S. than any other company. Additionally, it’s well-diversified internationally, with towers in fast-growing markets such as India, Brazil, and Mexico.

American Tower’s large number of locations puts the company in a good position to profit from the increasing demand for mobile data. Wireless carriers are building out their 5G networks, requiring new tower sites and equipment. American Tower's infrastructure is best suited for installing 5G networks in suburban and rural areas with fewer people.

On the negative side, consolidation among wireless carriers — both in the U.S. and internationally — has led to higher churn rates for tower contracts. That’s an industry-wide challenge, and it may lead to some acquisition opportunities for American Tower as smaller companies look to divest their assets. Meanwhile, long-term contracts allow for fairly predictable revenue.

American Tower entered the data center business in 2021 with the acquisition of CoreSite. The acquisition and further investment in data centers could give the company a significant presence in the growing edge computing space but could also distract from its core tower business.

As a real estate investment trust (REIT), American Tower pays out at least 90% of its taxable income to shareholders every quarter. With a strong position in the growing U.S. market, sites in many developing markets, high switching costs for its tenants, and contractual annual rate increases, American Tower's net income and dividend are both likely to keep rising.

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Telecom industry trends

The major trends driving growth in the telecom industry are the need for faster internet and the increasing number of internet-connected devices. Wireless carriers in the U.S. and around the world are working to build out their 5G networks as quickly as possible to support demand from both consumers and enterprises.

The COVID-19 pandemic drove a surge in demand for connectivity provided by telecom companies. New home buyers and people working from home increased demand. U.S. wireless carriers added even more subscribers in 2021 as growth in connections outpaced population growth. That said, home internet signups slowed as home buying slowed down, and analysts expect wireless net adds to slow as well.

Meanwhile, wireless carriers are expanding their services to include home internet through fixed-wireless access on their 5G networks. Although rural markets with few high-speed internet options are the main target market for such services, they present a threat to the cable companies dominating the urban and suburban markets.

Denser communications networks are also becoming necessary, driven by the growth of the Internet of Things, smart cities, and people working from home. Consumer devices such as smartphones, wearables, and smart speakers are proliferating and increasing the need for networks to support many connections at once. The rise of edge computing is also boosting the need for denser communications networks.

Picking the best telecom stocks

Any top telecom company is well positioned to profit from the prevailing trends in the sector. The best telecom stocks also tend to share these characteristics:

  • Economies of scale: A large scale of operations can confer major advantages in the telecom industry. High fixed costs make it necessary to capture a large subscriber base, and enjoying economies of scale relative to competitors can produce attractive gross margins and free cash flows.
  • Sustainable competitive advantages: Telecom companies with strategic holdings, such as radio spectrum licenses, land rights, or unique intellectual property, are uniquely positioned to compete. Strong branding and high switching costs are other types of relevant competitive advantages.
  • Healthy balance sheet: While telecom companies' recurring revenues enable them to assume substantial debt, the best telecom companies avoid high debt levels. Companies with healthy balance sheets have reasonable debt-to-equity ratios and ratios of debt as a percentage of invested capital.
  • Strong free cash flow: Although telecom companies produce lots of recurring revenue, maintaining a communications network is extremely expensive. Companies with strong free cash flows have enough cash remaining each quarter to support necessary infrastructure investments in addition to maintaining or increasing a regular dividend.
  • Growth potential: The top telecom companies have specific and realistic plans to capitalize on the trends driving the impressive growth in the telecom industry rather than simply relying on industry tailwinds to grow.

The best telecommunications companies are generally already market leaders. Any dominant telecom company that continues to leverage its competitive advantages while maintaining good fiscal discipline is likely to continue to reward investors — whether via stock price appreciation, dividend increases, or both.

Adam Levy has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends American Tower. The Motley Fool recommends Comcast and Verizon Communications. The Motley Fool has a disclosure policy