Alphabet Stock Analysis and Short-Term Strategy Alphabet Stock Drops as Free Cash Flow Deteriorates, Potential Opportunity Ahead

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By Ronald Tech

Alphabet (GOOG, GOOGL) stock has declined after the company unveiled underwhelming results for Q4. The primary driver was a significant decrease in its free cash flow (FCF) following a rise in capital expenditures (capex). Despite this setback, there may be an opportunity for investors to capitalize on the stock’s dip. I estimate its value to be at least $170 per share, representing a potential increase of 21.5% from its current level.

In a prior Barchart article, I suggested that GOOGL stock could be valued at $221 per share based on its robust Q3 FCF margins. However, at that time, the average analyst price target was $165 per share, according to AnaChart.com.

During morning trading on Feb. 2, 2024, GOOG stock was priced at $140.13, down from its recent peak of $153.91 at the end of January.

Tepid FCF Results

Alphabet reported unsatisfactory results on Jan. 30, 2024. While revenue increased by 13% year over year (YoY), the operating margin declined to 27% from 28% in the previous quarter. However, it’s worth noting that Alphabet’s year-earlier operating margin was even lower at 25%, indicating some progress over the past year.

Of greater concern, Alphabet’s FCF declined to just under $8 billion in Q4 2023 compared to the $16.02 billion in FCF generated in the prior year. In Q3, the company had produced $22.6 billion in FCF.

This resulted in a significantly lower FCF margin in Q4, with the FCF margin dropping to 9.25% based on its $86.13 billion in revenue. The substantial reduction from the 29.5% FCF margin in Q3 was partly due to increased capex spending in the last quarter. For instance, Alphabet’s capex spending rose to $11 billion in Q4, compared to $8 billion in Q3 and $7.6 billion a year ago.

Forecasting FCF Going Forward

Notwithstanding these challenges, Alphabet generated $69.5 billion in FCF over the last year, resulting in an average FCF margin of 22.6% based on its $307.3 billion in revenue. If this trend continues, Alphabet could potentially generate $77 billion in FCF for 2024, based on analysts’ estimates of $342.2 billion in revenue. Even a 22% FCF margin would forecast $75.3 billion in FCF for 2024.

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By using a 3.5% FCF yield, equivalent to a 28.4x multiple, Alphabet’s market cap could be valued at $2,139 billion, reflecting a 21.5% increase from its current market cap of $1.76 trillion.

Consequently, this implies that GOOGL stock may be valued at $170 per share, marking a 21.5% potential gain.

Analysts Still Like GOOGL Stock

Analysts remain optimistic about GOOGL stock. According to AnaChart.com, a survey of 42 analysts indicates an average price target of $162.14 per share, representing a 14.86% increase from the previous day’s closing price of $141.16.

Rob Sanderson, an analyst at Loop Capital, has demonstrated strong forecasting performance for GOOG and GOOGL stock. His consistent price target of $140 per share further underscores the positive sentiment for the stock.

Yahoo! Finance’s survey of 42 analysts reveals the average price target to be $159.83 per share, indicating a 13.6% upside from the current price.

Overall, GOOGL stock appears to present an attractive opportunity, both in terms of its FCF margins and the average price targets of other analysts.

Shorting OTM Puts

Existing shareholders have the option to potentially benefit from this situation by shorting out-of-the-money (OTM) put options, allowing them to generate income while awaiting a stock price increase. Despite generating FCF, Alphabet does not currently pay a dividend, unlike its peers such as Microsoft Corp (MSFT) and Meta Platforms (META), both of which pay dividends.

For instance, the $135 strike price put option expiring on Feb. 23 is trading at $1.01 on the bid side, providing immediate yield to the short put investor.

GOOGL Puts – Expiring Feb. 23 – Barchart – As of Feb. 2, 2024

In essence, by utilizing $13,500 in cash and/or margin with the brokerage firm, an investor can earn $101 by selling short this put, thereby “Selling to Open” 1 put contract at $135.00. As this strike price is more than 3.5% below the current price, it offers some downside protection. Even if the stock declines to this level, the investor is only obligated to purchase 100 shares at $135 per share, potentially resulting in an average capital loss for the investor.

Ultimately, GOOGL stock presents an appealing opportunity, particularly for the short-put investor.

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