Alphabet (Google) and Facebook stocks are reclassified. Here an attendee works on a laptop before the start of the Google I/O 2018 Conference May 8, 2018 in Mountain View, California. (Photo by Justin Sullivan/Getty Images)
There’s a somewhat unprecedented shake-up taking place within institutional investment portfolios this summer; individual investors need to learn about it so that they don’t get left in the dust, cautions Crista Huff, editor of Cabot Undervalued Stocks Investor and MoneyShow.com contributor.
An official reorganization of the Global Industry Classification Standard (GICS) has begun, and will continue through its September 28 deadline. GICS classifies stocks into 11 sectors and dozens of industries, and is commonly used in professional portfolio management as a guideline to portfolio diversity. It’s also used to identify stocks that can be included in sector funds (mutual funds and ETFs).
This GICS reorganization is going to cause stock volatility and provide opportunities for several months. Let’s nail down some of the intricacies of what’s about to take place. Then we’ll look at some of the affected stocks and decide whether they’re a buy, hold or sell.
The telecommunications services sector will be renamed communications services.
Importantly,
Alphabet
Facebook
The selling activity will push the share prices down. For example, the iShares Global Technology ETF holds $1.8 billion of stocks. Three of their five biggest holdings are Facebook and two classes of Alphabet. In addition,
Walt Disney
Comcast
Netflix
Portfolio managers of communications services funds will likely add Comcast, Disney, Facebook, Alphabet and/or Netflix to their funds. Here’s the important detail: there are far more information technology sector funds than there are communications services sector funds. Therefore, the total amount of selling activity among Comcast, Disney, Facebook, Alphabet and Netflix will not be offset by an equal amount of buying among sector funds. The imbalance could cause the share prices to drop and remain low for several months.
While the telecommunications services sector currently makes up less than 2% of the S&P 500, the new communications services sector will comprise 10% of the S&P 500. Now imagine that you are the portfolio manager of the iShares Global Telecom ETF with $350 million in assets. Your investment policy states that you are required to be invested in most of the incoming communications services sector stocks.
Your asset base does not change: you still have $350 million to play with. But now you’re required to spread that $350 million to cover many more stocks that are joining the sector. The only way you can do that is by selling portions of your current holdings – the top holdings in the ETF are
AT&T
That’s going to push share prices down on all of the pre-existing communications services portfolio stocks that you sell. Individual investors who own the original stocks within the communications services sector will need to be prepared to experience a possible downturn in their share prices.
It isn’t just mutual funds and ETFs that will need to readjust their portfolios. Most large institutional portfolios, such as pension fund portfolios, also allocate capital across sectors in order to maintain diversification and lower overall portfolio risk. These portfolios will be doing much of the aforementioned buying and selling of famous stocks, with a twist.
As they reexamine their sector holdings in light of the new category components, they’re occasionally going to find themselves overweight in a sector. If they’re overweight in communications services, they’re going to decide which stocks to keep and which to sell.
Given a choice between selling two of the following stocks, which would you sell: AT&T, Disney, Comcast, Facebook, Alphabet, Netflix and Verizon? Suddenly AT&T and Verizon will be competing for portfolio attention with far more glamorous companies. So, there’s going to be ongoing selling pressure for the next four months as literally every professional investor in the U.S. readjusts their portfolios. Wow.
But wait, there’s more. When portfolio managers remove Facebook and Alphabet from their technology sector allocations, they’re going to free up room within their technology sector weightings to add more technology stocks. Whoa. We’re talking about software and hardware and semiconductors and more. Which are your favorites?
Apple
Intel
If you are concerned that you own a stock that might see its price decline in the coming months, there are at least four things you can do:
- You can hold the stock, and consider buying more shares if the price becomes depressed.
- You can sell the stock now, with the intention of repurchasing the shares if a lower price presents itself.
- You can hold the stock and use stop-loss orders to protect your downside.
- You can consider using equity options strategies to protect yourself and/or to capitalize on the volatility.
Here’s some important GICS reorganization information from
MSCI
As portfolio managers shuffle stocks within the communications services sector, one of the first stocks to go from growth portfolios will likely be AT&T or Verizon. AT&T is projected to see earnings per share (EPS) grow just 1% in 2019. The 6.1% dividend yield will cause some portfolio managers to hold the stock, but growth managers need to deliver capital appreciation, which is unreasonable to expect from a company with stagnant profits.
Verizon is no better, with 2% expected 2019 EPS growth and a 5.0% dividend yield. Lots of portfolio managers are going to dump at least one of these two lumbering blue-chips, and here are the potential deciding factors: Verizon’s long-term debt-to-capitalization ratio is 66% whereas AT&T’s is 43%. Debt really strangles a company’s ability to function well.
The logos for Time Warner and ATT above alternate trading posts on the floor of the New York Stock Exchange. A federal judge has approved the $85 billion mega-merger of AT&T and Time Warner, potentially ushering in a wave of media consolidation while shaping how much consumers pay for streaming TV and movies. (File photo by Richard Drew/AP)
However, AT&T is in the process of purchasing
Time Warner
When big companies like AT&T and Time Warner merge, the new stock tends to stagnate for almost exactly nine months after the close of the deal. At that point, if financial targets are being met and profits are projected to grow nicely – maybe 10% to 20% in the coming year – only then does the stock begin to rise.
As a growth & value investor, I see no reason to own either AT&T or Verizon shares, because they’re not delivering any earnings growth to speak of, yet institutional portfolio managers are unlikely to sell both stocks. They have investment committees to report to.
They can’t just sell both AT&T and Verizon without doing some pretty fancy explaining, so they’re going to keep the one that’s easier to justify. My guess is that they’ll keep AT&T shares due to the general excitement over the Time Warner merger. It’s going to be easy to convince chief investment officers that the big merger AT&T-Time Warner could turn out well, thereby postponing a difficult sell decision, and taking the easy way out by selling Verizon.
So what will they buy to fill in the communications services sector of their portfolios? Given a choice between Alphabet and Facebook, each coming in from the technology sector, I’d choose Facebook in a heartbeat. Here’s why: Alphabet’s earnings growth is slowing dramatically, expected to be just 7.3% in 2019, and the corresponding P/E is very high in comparison at 24.3.