Look past the internet’s highfliers and go with companies helping to move data.
Thanks to the proliferation of smartphones, social media, and streaming video and audio, global Internet traffic has taken flight. Online traffic is expected to triple by 2018, driven largely by the projected 11-fold increase in the data coursing through mobile devices.
Alas, the valuations for many of the stocks on the leading edge of this revolution—such as Facebook and Netflix—are soaring too (see the chart). At the same time, other high-profile players, like Twitter and Pandora Media, aren’t even profitable yet, which doesn’t exactly give you a margin of safety for investing in tech’s next leap forward.
While the new kids on the tech block may be too rich for value-minded investors, that’s not the case for many of the sector’s older, more established names—companies that were once viewed as cutting edge but have been overlooked for years now. In fact, many of these stocks trade well below their 2000 peaks and are only slightly above where they were before the financial crisis.
“We see opportunity in large legacy technology companies,” says Jamie Doyle, a manager at Causeway Capital, which manages more than $30 billion in value portfolios. “Sure, they’ve slowed down from their early days,” Doyle says, “but they are still growing at rates other sectors are envious of.”
But which parts of old tech should you be focusing on?
1) Start With the Toll Takers
The rise of social and streaming media doesn’t benefit just content providers like YouTube, owned by Google, and Facebook’s Instagram. “The unstoppable digitization of everything creates a demand for the companies that provide the physical infrastructure to transmit, store, and manage all that data,” notes Jun Zhu, a senior analyst at the Leuthold Group.
Zhu singles out Internet service providers and infrastructure com- panies as the most compelling old-school plays on new tech. They include telecoms like Verizon VERIZON COMMUNICATIONS INC. VZ -2.46% and AT&T AT&T INC. T -1.85% that are the “toll takers” on the Internet highway, running the systems that move and manage data.
ISPs don’t merely collect sub- scription fees from users; they also negotiate interconnect fees from content distributors like Netflix and Apple to ensure fast speeds. As demand grows, ISPs gain leverage to assess bigger tolls.
While telecoms are traditionally slow growers, profits are picking up. Verizon’s earnings, for instance, are expected to grow 8% annually over the next five years, vs. just 3% over the past five, according to Zacks.com.
2) Seek Other Equipment Makers
If the explosion of online traffic benefits Internet service providers, it stands to reason that equipment manufacturers that sell to those ISPs ought to profit too.
While Cisco Systems CISCO SYSTEMS INC. CSCO -0.63% is only one-fourth as big in stock market value as it was in the late 1990s, it remains the dominant manufacturer of routers and switches used by cable and telecom firms globally. The IT giant enjoys a 50% share of a business with profit margins of around 60%, according to Morningstar. Thanks in part to that business, Cisco’s earnings are expected to grow more than 10% annually for the next three to five years—20% faster than the broad market.
Meanwhile, every time you tweet, stream a high-definition movie, or update your Facebook page, there’s a good chance you’re doing so on a smartphone. Qualcomm QUALCOMM INC. QCOM 2.36% is well positioned to benefit from that trend.
In addition to making mobile chips, Qualcomm owns the patents on the technology behind most 3G and 4G networks that smartphones are on, notes Eric Vermulm, senior portfolio manager at Stack Financial Management. The royalties the company receives generate two-thirds of its profits. And Qualcomm’s earnings are expected to grow 15% annually.
3) Or Just Buy a Fund
An added benefit of old tech is that it pays you to wait for long-term trends to develop. Verizon and AT&T have long been among the market’s biggest yielders. And they’re among the top five holdings of Technology Select Sector SPDR ETF TECHNOLOGY SELECT SECTOR SPDR ETF XLK -0.46% . Morningstar estimates that the portfolio’s current dividend payouts equate to a nearly 3% annualized yield.
Another plus: The ETF holds tech’s biggest stocks. And as Vermulm notes, “at this late stage, large-cap blue chips with solid balance sheets are the sorts of companies we want to own.”