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Alphabet Inc (GOOG, GOOGL) produced good results last quarter with higher revenue and margins. As a result, GOOGL stock looks inexpensive to some and is attractive to short-put sellers as an income play.
I discussed this in my last Barchart article on Feb. 2, “Alphabet Stock Drops as Its Free Cash Flow Dips, But GOOGL Could Be Cheap Here.” At the time GOOGL stock was $140.63, and on Feb. 16 it closed at $140.52, or roughly flat.
I had discussed selling short the $135 strike price put options that expire on Feb. 23. The premium at the time was $1.01 per put and today those trade for 30 cents in the mid-price. So that trade is continuing to work out. It makes sense to roll this trade over now.
But first, let's review why GOOGL stock looks cheap here.
Alphabet's Strong Free Cash Flow
Alphabet's Q4 2023 released on Jan. 30, 2024, showed that revenue rose 13% YoY and its full-year revenue was up 9% YoY. Moreover, its operating margins (i..e, operating profit divided by sales) rose from 24% in Q4 2022 to 27% in Q4 23.
Its FCF was also strong. Alphabet generated $69.5 billion in FCF in 2023. That works out to an average FCF margin of 22.6% given its revenue of $307.3 billion.
So, using analysts' estimates of $342.4 billion in revenue for 2024, it could lead to $75.3 billion in FCF for 2024. That is based on an average of 22% FCF margin throughout the year (i.e., $342.2b x 0.22 = $75.3b).
This implies that the stock could rise to a market value of $2,259 billion (i.e., $2.26 trillion). That is the result of using a 3.3% FCF yield metric. This is the same as multiplying the FCF estimate of $75.3 billion by 30x since the inverse of 3.3% is 30.
This market cap estimate of $2.259 trillion is 29% higher than the stock's present market value of $1.75 trillion. In other words, GOOGL stock is worth 29% more than its price of $140.52. That puts the price target at 181.27 per share.
One way for existing shareholders to take advantage of this is to sell short out-of-the-money (OTM) put options in nearby expiry periods.
Selling OTM Puts in GOOGL Stock for Income
For example, look at the March 8 expiration period for GOOGL stock, which is three weeks away. It shows that the $135 strike price puts, which are about 4% below today's price, trade for $1.11 on the bid side.
That works out to an immediate yield of 0.82% (i.e., $1.11/$135.00) to the short seller of these puts.
For example, assuming the investor secures $13,500 in cash and/or margin with their brokerage firm, they can enter an order to “Sell to Open” 1 put contract. That means by selling the $135 strike price for expiration on March 8, their account will immediately receive $111.
So, if they can repeat this trade 4 times during a quarter, it will accumulate $444. That represents an expected return of 3.29% on the $13,500 invested in this income strategy.
The bottom line is that GOOGL stock looks cheap here. One way to make an income while waiting is to sell short out-of-the-money puts.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
