Much has changed in telecommunications since Ma Bell dominated the industry 20 years ago. AT&T was broken up into small chunks in 1984, but since then many of those chunks have merged back together. Meanwhile, the Internet and other newer technologies have given rise to a flock of startup telecom companies, and sky-high growth rates and stock valuations are the norm in this group.
Investors should be selective when buying telecom stocks, however. One way to play this industry is to sort its companies into established players, merger maniacs and promising start-ups. An investment in one company from each group would spread risk while still taking advantage of advances in the telecom industry.
Among the established players, SBC Communications looks like a smart idea. This company is parent to the former Southwestern Bell, which has since merged with some of its Baby Bell siblings. SBC is an established, reliable company with a cheap stock price and healthy 2.3 percent dividend yield. Morningstar gives the company an A grade for valuation, considering its stock undervalued when it trades below $47.25 per share.
While much of SBC's business is tied to older business lines, such as local telephone service, the company has strong growth possibilities as well. SBC has launched Project Pronto, its effort to bring high-speed Internet access to customers' homes through digital subscriber lines. The company has also begun to offer local telephone and Internet service in markets where it isn't a dominant player.
Another appealing telecom stock is WorldCom, which falls into the merger maniac category. WorldCom's deal to buy Sprint broke off recently after federal regulators frowned on the deal, but investors should stick with the company anyway. WorldCom has the largest Internet backbone of any company in the world, and the firm should be able to leverage that size and expertise as demand for Internet services continues to grow.
WorldCom shares aren't without risk, of course. Revenue growth from the company's long-distance service is tapering, and it lacks a wireless-telephone strategy now that the Sprint deal has been cancelled. Still, WorldCom shares look fairly cheap. Morningstar gives the company an A-minus grade for valuation and appraises the stock at about $42.
Finally, if your tolerance for risk is high, take a look at Level 3 Communications. This promising start-up, which sells capacity on its fiber-optic network so others may transmit calls and Internet data, has yet to prove that it generates enough profit to warrant its pricey valuation. (The stock is trading at a whopping 32 times sales.)
Level 3's potential is huge, however. The company thus far has focused on building up its network, and revenue growth should expand significantly in the coming years. Furthermore, the company has a strong management team and a solid balance sheet with about $7 billion in cash reserves. It's likely that this company will be successful over the long term, but investors should be prepared for a big fall in the stock price if Level 3 has even the slightest stumble.