Why you should avoid the telecoms sector

As Carphone Warehouse's shareholders found last week, the telecoms sector can be extremely volatile. And with the broadband wars picking up pace, the bloodletting may be just beginning…

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Last week was an exciting one for Carphone Warehouse shareholders - rather too exciting for most.

First the company was forced to announce that unexpectedly high uptake of its broadband offering would cost it £20m more than expected this year. Then it bought over AOL's UK division for £370m, much to the delight of shareholders - the deal made it the third-biggest broadband provider in the UK.

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But the euphoria turned to despair once again, as Vodafone ended its 17-year relationship with the group, citing concerns that Carphones continued expansion into other telecoms services would "increasingly overlap" with Vodafone's business and strategies .

It goes to show just how volatile operating in the telecoms sector can be. And with the broadband wars picking up pace, the bloodletting may be just beginning

Anyone with an internet connection can't fail to have noticed the various cheap package deals that are being thrown at them by the country's broadband suppliers. There's Carphone Warehouse's famous free' broadband offer, of course; BSkyB also offers free' broadband, as long as you sign up for their TV packages; and other providers include NTL and BT while Vodafone and Orange also moving into the broadband arena.

Why are these companies offering such good deals? The answer's pretty simple - it's land grab time in the communications sector. As anyone who's tried to change their broadband provider knows, doing so is a complete pain in the neck. Most of the time it will mean going without an internet connection for a prolonged period of time - and as most of the people who currently have broadband almost certainly rely on it for their work to some extent, that's not at all convenient.

So basically, if you can get someone to sign up for your service, there's a good chance that you've got a customer for life - or at least, until someone comes up with a more convenient method of switching services.

On top of this, most broadband deals involve being tied to the provider for at least a year. And then there's the additional services that come as part of the deal - landline, television channels, and increasingly, mobile phone services. All of these provide potential added revenue streams, from advertising to pay-per-view, to game playing - so you can see why in the longer term, providers are happy to sacrifice profit margins for new sign-ups.

This conflict is great news for consumers, of course - it means faster internet access, cheaper phone calls and a broader range of TV channels, if you're so inclined. But the trouble in the meantime for those who actually own shares in any of the suppliers is that it's hard to know who will come out on top.

It might be easier to predict if not for the fact that rapid advances in technology mean that the communications landscape is always changing. The gradual merging of all these services has brought once fairly distinct sectors into direct competition with one another. When they launched, few people would have suspected that one day a mobile phone shopping chain like Carphone Warehouse and a broadcaster such as BSkyB would be in direct competition with one another.

And as Carphone Warehouse has learned, this overlap can cause real problems. Now that Vodafone and potentially Orange are competing with Carphone in the broadband market, its no surprise that they might be keen to undermine the groups core mobile retailing business by withdrawing their support.

One thing's for sure - it will take some time for the dust to settle - and who's to say we won't see another technological innovation in that time that will render that land grab entirely fruitless? After all, it is bound to become easier to switch suppliers.

And of course, technological advances in other areas are constantly threatening to completely transform the rules of the game. For example, some companies are now offering ways to make mobile phone calls over the internet, in the same way that cheap or free landline calls can currently be made between home computers. Widespread adoption of this technology would surely be bad news for the current mobile phone majors.

And then there's all the hype over social networks, and sites like YouTube, which more than a few experts suspect may be more 'flash in the pan' rather than the 'next big thing', despite - or perhaps because of - the massive sums being forked out for them.

From an investment point of view, there's still too much uncertainty and change to come in the telecoms world for our liking - as Carphone Warehouse shareholders have found out. You might be tempted to trawl through the sector for the most promising stocks, and you may even pick the right ones. But given that over time, studies prove that most successful investors make money by having their cash invested in the right sectors at the right times, rather than by picking the right stocks, the odds are against it.

In short, with plenty of fighting still to come, we think the best way for the typical investor to benefit from the broadband wars is to enjoy being able to take advantage of increasingly fast connections at decreasing cost. And then you can use your snappy new internet connection to research other sectors with more promising fundamentals for some decent stocks to buy.

Turning to the markets...

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The FTSE 100 closed at a record 5-year high on Friday, as strength amongst miners and enouraging results from Lloyds TSB propelled the index 36 points higher to end the day at 6,157. BP was among the risers as one of the main beneficieries of the firmer oil price. For a full market report, see: London market close

On the Continent, the German DAX-30 was also higher, closing up 13 points at 6,173. However, the Paris CAC-40 ended its run of gains as investors took profits on Friday; the index fell 8 points to close at 5,353.

On Wall Street, the Dow Jones once again closed at a record high, finishing 12 points firmer at 11,960, boosted by gains from Microsoft, Intel and Exxon Mobil. The Nasdaq closed 11 points higher, at 2,357, ending the week with an overall gain of 2.5%. The S&P 500, meanwhile, closed 2 points higher at 1,365.

In Asia, the Nikkei reached a 5-month high of 16,692 as strength from leading stocks Sony, Canon and Honda saw the index climb 156 points, or nearly 1%.

Crude oil was higher again today, last trading at $59.04. Brent spot was nearly 1% higher, at $59.22.

Spot gold hit a two-week high of $592.50 this morning, before dropping back to $590/oz.

And in London this morning, music company EMI Group announced a 5% fall in first-half revenue, blaming a release schedule weighted more than usual towards the second half of the year. Digital music sales doubled to $945m, 11% of the total music market, as CD sales fell. The company expects strong full-year growth on the back of new releases by artists such as Norah Jones and Robbie Williams in the second half.

And our two recommended articles for today...

What do stock market highs mean for gold investors?

- US stock markets have been surprisingly strong of late, despite concerns over slowing economic growth. What does this mean for gold's 'safe haven' status? The metal has already fallen more than 20% since its May highs but gold bug Paul van Eeden says he'd be happy for it to fall even lower. To find out why, read: What do stock market highs mean for gold investors?

The high cost of stock market resilience

- The global economy has demonstrated extraordinary resilience of late, enduring gepolitical crises, burst asset bubbles and high oil prices with barely a murmur. But at what cost? asks economist Stephen Roach. For his analysis of the problems we are storing up for the future, see: The high cost of stock market resilience

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.