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Strategist Tom Lee says these stocks are 'pariahs,' so buy them

  • Fundstrat's Tom Lee recommends buying "pariah" telecom, predicting company consolidation under the Trump administration.
  • Price competition and slow growth continue to spook investors as analysts slash ratings.
  • Telecommunications is the only sector with dividends that exceed debt.

Fundstrat strategist Tom Lee recommends investors buy "pariah" telecommunications stocks, predicting that companies in the beaten down sector are likely to bounce back under the Trump administration.

Slow growth and price competition have spooked investors away from telecom stocks, he said. Even analysts have backed away, slashing their recommendations in the last year. Telecom as a sector is at its lowest average analyst rating in a decade.

Formerly JPMorgan's chief equity strategist, Lee is one of the market's biggest bears. As recently as last week, he reaffirmed his year-end 2,275 price target for the S&P 500, which would be a 6 percent decline from Thursday's close. The estimate is the lowest target on Wall Street according to CNBC's Market Strategist Survey.

But despite telecom's rocky start to the year, the Fundstrat strategist sees the sector climbing back.

"Clearly, the industry needs to consolidate, and it is increasingly evident (to investors, at least) that carriers face greater intermodal competition," wrote Lee in Friday's note to clients, referring to competition among cable, wireless, and telephone companies. "With a more business friendly administration, the probability of beneficial consolidation is high."

Currently, industry giants AT&T and Verizon eclipse smaller firms like T-Mobile, Dish, and Sprint. But, Lee noted, tie-ups of three or four smaller firms could pool enough wireless spectrum to rival the industry leaders.

"Notably, Dish, Comcast, [and] Globalstar hold substantial spectrum that, combined with one of the existing mobile carriers, enhances a carrier's footprint," continued Lee, concluding that such consolidation would actually foster competition with AT&T and Verizon.

Last year's tie-up of AT&T and Time Warner may signal a shift in the industry's luck. Questions about how the Trump-era Justice Department and Federal Communications Commission will decide on potential consolidations remain unanswered.

But Lee sees something else attractive about telecom: dividend yields.

Telecom's 5.1 percent dividend yield dwarfs the 3.5 percent for utilities and is 150 basis points higher than telecom's cost of debt, the analyst noted. "Moreover, as shown, the weighted average cost of debt is 3.6% which is in-line with the overall market and thus, is the only sector where the dividend yield exceeds the cost of debt," he said.

The Fundstrat report adds that Verizon and AT&T could launch a massive equity buyback of 12 percent to 20 percent given their high dividends and low equity valuations.