Everyone is focused on artificial intelligence ("AI") this year...

AI is what's driving the market higher. It seems like every company is trying to figure out how to get more efficient with this technology.

And yet, as we listen to earnings calls and watch interviews with CEOs, we've noticed another theme cropping up time and time again.

I'm talking about the challenges of navigating the U.S. and China's relationship.

Things have been complicated between these two nations for years. They've gotten even more complicated since the pandemic. U.S. companies are moving out of China in favor of bringing global supply chains closer to home.

And this bifurcation is developing in other parts of the world economy. One area that's increasingly contentious has to do with the infrastructure that supports the Internet...

Subsea fiber-optic cables are a big area of concern. These cables allow Internet traffic to flow seamlessly across the globe. China has started making moves to control more of this infrastructure.

The geopolitics of "listening devices" and "controlling the pipelines of economic activity" tend to catch the most headlines. Today, we'll focus instead on isolationist policy... and how it might create an overlooked winner in the Internet-infrastructure arms race.

French, Japanese, and U.S. companies have traditionally dominated the supply and installation of these cables...

These big fiber-optic cable players have spent decades building out ways to connect the world. They've collectively created nearly 1.4 million kilometers of subsea cables.

However, China has been making inroads into this market. It has developed more than 75,000 kilometers of cable... almost enough to wrap the circumference of the Earth twice.

It's no wonder some experts are concerned about espionage and rising geopolitical tensions.

As tensions get more serious – and as each bloc ramps up investments to win this race – demand will soar for fiber-optics services. Megatrends like the Internet of Things ("IoT") will only fuel that demand even further.

And the businesses involved in building out fiber-optics networks will be huge beneficiaries.

TE Connectivity (TEL) is one of the likely winners of this trend...

The company makes equipment that allows fiber-optic cables to connect the world.

TE Connectivity is what we call a "picks and shovels" play on the fiber-optics industry. It sells the supplies that fiber-optics companies rely on... So it's poised to benefit from all that booming demand, no matter which companies are responsible for actually laying new cables.

Still, the market doesn't seem to care about these tailwinds. We can see what the market is pricing in for the company by looking at the Embedded Expectations Analysis ("EEA")...

The EEA starts by looking at a company's current stock price. From there, we can calculate what the market expects from the company's future cash flows. We then compare that with our own cash-flow projections.

In short, it tells us how well a company has to perform in the future to be worth what the market is paying for it today.

TE Connectivity's Uniform return on assets ("ROA") grew from 16% in 2018 to 20% in 2022. The only year it fell was in 2020, when operations were disrupted by the pandemic.

That rising profitability is due to growing global cable investment. Said another way, TE Connectivity is already benefiting from increased demand.

And yet, at current valuations, the market believes the company's ROA will fall to 15% by 2027... even lower than it was five years ago.

Take a look...

TE Connectivity's profitability has been rising for years as the world invests in more subsea cables. Investors are completely missing the trend.

France, Japan, and the U.S. want to keep their dominance over China. China is trying to play catch-up.

All of that means years of demand for the fiber-optic cable industry... and no reason for TE Connectivity's returns to crater. Investors who capitalize on this opportunity should see significant upside.


Joel Litman
July 6, 2023