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?)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Investing

    How ETFs May Save You Thousands

    Being vigilant about the amount you pay and what you get for is important, but adding ETFs into the investment mix fits well with a value-seeking nature.
  2. Stock Analysis

    The Biggest Risks of Investing in Netflix Stock

    Examine the current state of Netflix Inc., and learn about three of the major fundamental risks that the company is currently facing.
  3. Mutual Funds & ETFs

    3 Fixed Income ETFs in the Mining Sector

    Learn about the top three metals and mining exchange-traded funds (ETFs), and explore analyses of their characteristics and how investors can benefit from these ETFs.
  4. Stock Analysis

    What Seagate Gains by Acquiring Dot Hill Systems

    Examine the Seagate acquisition of Dot Hill Systems, and learn what Seagate is looking to gain by acquiring Dot Hill's software technology.
  5. Chart Advisor

    Agriculture Commodities Are In The Bear's Sights

    Agriculture stocks have experienced strong moves higher over recent weeks, but chart patterns on sugar, corn and wheat are suggesting the moves could be short lived.
  6. Investing News

    Top Tips for Diversifying with Mutual Funds

    Are mutual funds becoming obsolete? If they have something to offer, which funds should you consider for diversification?
  7. Professionals

    Top Stocks to Short, Go Long On to Beat the Market

    A long/short portfolio can help weather a variety of market scenarios. Here's how to put one together.
  8. Mutual Funds & ETFs

    Top 4 Asia-Pacific ETFs

    Learn about four of the best-performing exchange-traded funds, or ETFs, that offer investors exposure to the Asia-Pacific region.
  9. Mutual Funds & ETFs

    Top 3 Japanese Bond ETFs

    Learn about the top three exchange-traded funds (ETFs) that invest in sovereign and corporate bonds issued by developed countries, including Japan.
  10. Mutual Funds & ETFs

    What Exactly Are Arbitrage Mutual Funds?

    Learn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
  1. Can working capital be too high?

    A company's working capital ratio can be too high in the sense that an excessively high ratio is generally considered an ... Read Full Answer >>
  2. How do I use discounted cash flow (DCF) to value stock?

    Discounted cash flow (DCF) analysis can be a very helpful tool for analysts and investors in equity valuation. It provides ... Read Full Answer >>
  3. Can mutual funds invest in IPOs?

    Mutual funds can invest in initial public offerings (IPOS). However, most mutual funds have bylaws that prevent them from ... Read Full Answer >>
  4. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  5. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  6. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!