Searching For Ideas in the QFON Smart Phone Index

On April 12, 2010, the NASDAQ OMX Group and the Consumer Electronics Association announced the Smartphone Index (QFON),  a new benchmark for the telecommunications sector focused on wireless, mobile devices and advanced communication functionality.  It is a modified market-capitalization index and includes companies that are primarily involved in building, design and distribution of handsets, hardware, software, and mobile networks associated with the development, sale and usage of smartphones.

“Investors, thanks to this index, can now easily track companies that are working diligently to combine the benefits of the phone and computer in a single device,” says NASDAQ OMX Executive VP John Jacobs.

The Smartphone index is currently comprised of 84 companies that are screened by the Consumer Electronics Association, includes companies like Apple, Google and Research in Motion.  I am fairly certain that several ETFs will soon be created to emulate this index.  In the mean time, I have decided to take a look at the components to see if there are any stocks that have escaped my radar.  Here is the complete list.

To my dismay there were no undiscovered jewels in the index. I have been following the mobile industry fairly closely, so that shouldn’t have been a surprise.  What was surprising in a negative way was that  contract manufacturers like Jabil and Flextronics were  in the index.  They are certainly critical to the cell phone manufacturing process, but will do little to add alpha (excess performance) to the index.  Matter of fact, I quickly decided that this index wasn’t for me.  There were simply too many great companies/ crappy stocks in the index.  As an investor, it is paramount to separate the company from the stock.  Alcatel-Lucent is a great company (that may be a stretch), but its stock has been a chronic under performer.  All wasn’t lost as I decided to look at the index from another point of view.

I organized each company by industry – defining eight groups: Mobile Devices, Cell Towers, Communication Equipment, Components, Manufacturing Services, Wireless Carriers and Test Equipment.  Then I calculated each group’s performance year to date.  The results made this little exercise completely worthwhile and supported my conclusion in my blog “For Investors the Smartphone War is Over.

My bottom line in that blog was there are more profitable ways to benefit from the mobile computing cycle than buying stocks of the mobile device makers.  People are fanatical about their phones and the debates I have had are well chronicled on this blog.  However, I believe the greatest stock price appreciation will be rewarded to companies that help solve the “big problem” – people want to be connected 24/7 and want their data now.   The mobile holy grail is ubiquitous high-speed wireless connectivity.

The best performing industry in this analysis was Communication Equipment +26.0% year to date.  That’s some serious alpha when compared to the S&P 500 +6.9%.  Mobile Devices ranked last (#8 out of 8 groups) with a year to date performance of -3.5% .  A large part of that was due to Palm’s pathetic -44.3% performance.  Excluding Palm, Mobile Devices still only ranks #4 out of 8. Take a look here for the breakdown.

Although I didn’t find any jewels in the Smart Phone Index, I received further confirmation that the diamonds are in the guts of the mobile internet (the infrastructure plays).  My favorite play in this sector is NetLogic Microsystems +44.7% year to date.  They supply Application Specific Integrated Circuits (ASICs) to companies like Cisco, Alcatel-Lucent, Ericsson and others.  Guess what –  they aren’t included the Smart Phone Index.  That’s good for us.  Let’s buy it before smart guys wise up.

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