It's an insulting irony that nearly 1,000 exchange-traded funds (ETFs) are out there to choose from, yet the one you need more than any other right now still doesn't exist. Don't worry though - there's a reasonable solution.

And what, pray tell, is the one ETF that doesn't exist yet? Small cap telecom. (For more on telecom, check out How To Pick The Best Telecom Stocks.)

TUTORIAL: Exchange-Traded Funds

Fund Sponsor Skipped Small Cap Telecom

Early last year, PowerShares debuted nine new small cap ETFs. Problem is, there are 10 major sectors. Yes, small cap telecom was the one the fund sponsor skipped, noting that these telecom names could be effectively lumped into the PowerShare S&P SmallCap (600) Utilities Portfolio (Nasdaq:PSCU).

It's too bad, too, considering small cap telecom is a group that is just now starting to decidedly grow earnings again. More important, it's a group of stocks that - as a whole - only recently started to rebound.

What Took So Long?

As hard as it is to believe, the S&P 600 Telecom Index didn't participate in the rally that began in early 2009 - at all. It only moved back above its March 2009 levels in May of this year, and even then it's only up 4.9% for the two-year(+) period. For comparison, the S&P 500 'SPYders' Fund (NYSE:SPY) is up 60% for that time frame.

It wasn't a telecom thing either, as the iShares Dow Jones US Telecom Fund (NYSE:IYZ) - predominantly made of large caps - managed to gain 50% during that period. (For more information on the market, see When Is A Bull Market Not A Bull Market?)

What Happened Recently?

So what happened in the last few weeks to light a fire under the small caps from the telecom world? And make no mistake - the buying volume has gone ballistic. For the first time in years, the group index is making higher highs and higher lows.

The best answer is ... earnings growth, though there's a long footnote to go with the answer.

Though it sure didn't act like it since 2009, the S&P 600 Telecom Index - via its constituents - has been recovering on the earnings front. The index, currently priced at about $385, earned close to 11 cents "per share" in 2009, earned 13 cents in 2010, is on pace to earn 17 cents in 2011, and is estimated to earn 19 cents in 2012. The forward-looking P/E (2012) is a respectable 15.0.

A Head Scratcher

With just those numbers alone, it's a bit of a head scratcher. A stock's future is more important than its past, and the future was indeed looking brighter and brighter for small cap telecom through that whole two-year span. Valuations were never outrageous during that time either (at least not without a clear reason).

The most likely stumbling block is, or was, the fact that the index had earned 39 cents per share in 2007 and 45 cents in 2008. By comparison, any amount of growth was still going to be disappointing.

Well, though it took more than two years to get past it, the market's recent interest in the group implies that it is indeed over yesteryear's lofty earnings levels. Of course, severely lower stock prices since 2008 (not to mention low P/E levels) make it easier to wade into the growth trend now. (To learn more about growth and its total effect, read Is Growth Always A Good Thing?)

Picks of the Litter

Two compelling ideas from this universe rise to the surface almost immediately.

Cincinnati Bell (NYSE:CBB), with a foothold in the Southern Ohio market, didn't feel much love from the market in 2010, and understandably so - earnings slumped from 42 cents per share in 2009 to 31 cents. As is usually the case, though, there's more to the story.

In Cincinnati Bell's case, net earnings took a hit because the company was laying out some cash to start a new technology services venture called CyrusOne, which immediately generated more revenue, and will eventually generate stronger earnings. One would have to look beyond the recent numbers to know it, though, and many investors just don't bother. Indeed, the forward-looking P/E of 11.0 may still not do the stock justice.

Another compelling idea in the small cap telecom space is Consolidated Communications Holdings (Nasdaq:CNSL). It won't win any awards for a low valuation, but it's earned an "A" for consistent and reliable growth. And, with an 8.0% yield, an investor could do worse.

Bottom Line

There are some better - and smaller - ideas in this group than those two names, but the point is the bigger theme itself. Given that all of these telecoms are collectively getting their act together, and knowing how important a group is to an individual stock's performance, a little more digging here could pay off in a big way a year from now. (To help you identify if the industry is growing, check out Great Company Or Growing Industry?)

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Tickers in this Article: CNSL, CBB, IYZ, SPY, PSCU

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