The Zacks Communication - Components industry appears well poised to benefit from healthy demand trends and an increasing user propensity to stay abreast of the latest digital innovations. However, price volatility due to elevated customer inventory levels, high capital expenditures for infrastructure upgrades, margin erosion, geopolitical conflicts and raging wars have dented the industry’s profitability.

Nevertheless, Arista Networks, Inc. (ANET Quick QuoteANET - Free Report) , AudioCodes Ltd. (AUDC Quick QuoteAUDC - Free Report) and Turtle Beach Corporation (HEAR Quick QuoteHEAR - Free Report) are likely to gain in the long run as demand for scalable infrastructure for seamless connectivity rises with the wide proliferation of IoT, fiber densification, transition to cloud and accelerated 5G rollout.

Industry Description

The Zacks Communication - Components industry primarily comprises companies that provide diverse telecom products and services to develop scalable network architecture, demand-driven video solutions and broadband access equipment. These include various building blocks such as small cells, routers and antennas incorporated into equipment and facilities, and subsequently utilized by service providers to build networks for end users. Their product portfolio encompasses optical and copper connectivity products, hybrid fiber-coaxial equipment, edge routers, metro Wi-Fi, storage and distribution equipment for cable TV operators, modems, EMTAs (Embedded Multimedia Terminal Adapter), gateways, set-top boxes, analog and digital microphones, audio processors, glass substrates for LCD TVs and notebooks, ceramic substrates for mobile and laboratory filtration products.

What's Shaping the Future of the Communication Components Industry?

Network Convergence: With operators moving toward converged or multi-use network structures, combining voice, video and data communications into a single network, the industry is increasingly developing solutions with steady R&D investments to support wireline and wireless network convergence. These investments are likely to help minimize service delivery costs to adequately support broadband competition and expand rural coverage and wireless densification. The industry players have enabled enterprises to rapidly scale communications functionalities to a vast range of applications and devices with easy-to-use software application programming interfaces. The firms support high user volumes without affecting deliverability and cost-effectively eliminate performance degradation.

Shrinking Profit Margins: Although supply chain woes have declined progressively, the industry is facing a dearth of chips, which are the building blocks of various equipment used by telecom carriers. Moreover, high raw material prices due to the Israel-Hamas conflict, the prolonged Russia-Ukraine war and the consequent economic sanctions against the Putin regime have affected the operation schedule of various firms. High technological obsolescence of most products has escalated operating costs, while high customer inventory levels and a conservative approach toward placing orders for high-value items remain headwinds.

Focus on Cloud & Fiber Architecture: The firms are likely to benefit from a software-driven, data-centric approach that helps customers build their cloud architecture and enhance the cloud experience. The industry participants are well-poised for growth in data-driven cloud networking business with proactive platforms and predictive operations. Fiber networks are essential for the growing deployment of small cells that bring the network closer to the user and supplement macro networks to provide extensive coverage. Telecom service providers are increasingly leaning toward fiber optic cable to meet the burgeoning demand for cloud-based business data and video streaming services by individuals. Moreover, the fiber-optic cable network is vital for backhaul and last-mile local loops, which are required by wireless service providers to deploy the 5G network.

Demand Erosion: Efforts to offset substantial capital expenditure for upgrading network infrastructure by raising fees have reduced demand, as customers prefer to switch to lower-priced alternatives. In addition, the latent tension between the United States and China, relating to trade restrictions imposed on the sale of communication equipment to firms based in the communist country, has dented the industry’s credibility, leading to a loss of business. The industry is battling hard-to-mitigate operating risks stemming from volatility in demand, an unpredictable business environment and challenging geopolitical scenarios.

Zacks Industry Rank Indicates Bullish Trends

The Zacks Communication - Components industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #61, which places it among the top 24% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates solid prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.

Before we present a few communication component stocks that are well-positioned to outperform the market based on a strong earnings outlook, let’s take a look at the industry’s recent stock market performance and valuation picture.

Industry Outperforms S&P 500, Lags Sector

The Zacks Communication - Infrastructure industry has outperformed the S&P 500 composite but lagged the broader Zacks Computer and Technology sector over the past year.

The industry has rallied 44.7% over this period compared with the S&P 500 and sector’s rise of 32.1% and 45.7%, respectively.

One-Year Price Performance

Industry's Current Valuation

On the basis of the trailing 12-month price-to-book (P/B), the industry is currently trading at 5.02X compared with the S&P 500’s 6.47X. It is also below the sector’s trailing 12-month P/B of 6.5X.

Over the past five years, the industry has traded as high as 5.02X, as low as 2.02X and at the median of 3.4X, as the chart below shows.

Trailing 12-Month price-to-book (P/B) Ratio

3 Communication Components Stocks to Watch

Arista: Santa Clara, CA-based Arista provides cloud networking solutions for data centers and cloud computing environments. It offers one of the broadest product lines of data center and Ethernet switches and routers in the industry. The stock has gained 79.8% over the past year. The Zacks Consensus Estimate for the current and next fiscal earnings has been revised 15.1% and 21.9% upward, respectively, over the past year. It has a long-term earnings growth expectation of 17.5% and delivered an earnings surprise of 13.3%, on average, in the trailing four quarters.

Arista continues to benefit from the expanding cloud networking market, driven by strong demand for scalable infrastructure. In addition to high capacity and easy availability, its cloud networking solutions promise predictable performance and programmability that enable integration with third-party applications for network management, automation and orchestration. Arista currently carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Price and Consensus: ANET

AudioCodes: Incorporated in 1992 and headquartered in Lod, Israel, AudioCodes offers advanced communications software, products and productivity solutions for the digital workplace. Its product portfolio includes session border controllers, life cycle management solutions, VoIP network routing solutions, media gateways and servers, multi-service business routers, IP phone solutions and value-added applications, as well as professional services.  

AudioCodes is likely to benefit from the secular tailwinds related to IP-based communications. It aims to leverage its long-term partnership with Microsoft to further strengthen its market position. AudioCodes is also likely to benefit from its continued focus on high-margin businesses. This Zacks Rank #2 stock has a long-term earnings growth expectation of 24.8% and delivered an earnings surprise of 20.1%, on average, in the trailing four quarters. The Zacks Consensus Estimate for the current and next fiscal earnings has been revised 25.6% and 11.7% upward, respectively, since October 2023.

Price and Consensus: AUDC

Turtle Beach: Headquartered in White Plains, NY, it develops, commercializes and markets gaming headset solutions for various platforms, including video game and entertainment consoles, handheld consoles, personal computers, tablets and mobile devices under the Turtle Beach brand. The Zacks Consensus Estimate for the current and next fiscal earnings have been revised a stellar 1700% and 246.3% upward, respectively, since March 2023. The stock has surged 115% over the past year.

Turtle Beach is well-positioned to benefit from quality products and enjoys a solid foothold in its served markets. Its headsets are suited for learning and working remotely via video or audio conferencing. Turtle Beach is likely to benefit in the near term as retailers return to normalized inventory replenishment along with a solid video game release schedule and normalized console availability. This Zacks Rank #2 stock has a long-term earnings growth expectation of 16%. It has a VGM Score of A.

Price and Consensus: HEAR