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Alphabet (GOOG) has dropped just 1.83% in the August sell-off and it's now moving back up. In morning trading on Aug. 22, GOOG stock is at $130.67, down from $133.11 at the end of July. Alphabet's massive free cash flow (FCF) makes it attractive to value investors.
It also appeals to options traders who sell short out-of-the-money (OTM) put options for income.
I discussed these points in my July 30 Barchart article, “Alphabet Gushes Forth Record Free Cash Flow, Making GOOG Stock Cheap.” The article pointed out that Alphabet's Q2 results showed that its FCF was up 73% YoY.
Moreover, its QoQ FCF growth was over 26%. That is incredible. It helps explain why GOOG stock has performed reasonably well during the past month, despite the tech stock sell-off.
Where This Leaves Investors in GOOG Stock
As it stands, GOOG stock trades on a very reasonable forward price-to-earnings (P/E) multiple of just 23x for 2023 and 19.5x for the year ending Dec. 2024. That is well below its 5-year average forward P/E multiple of 25.1x, according to Morningstar.com.
So, if GOOG stock were to rise to its average forward multiple, GOOG stock would be worth 9.1% more using 2023 metrics (i.e., 25.1x/23x) and 28.7% more based on 2024 (i.e., 25.1x/19.5x).
That implies GOOG stock is worth between $142.56 per share and $168.17. That puts its average target price at $155.36 per share. That is slightly higher than Yahoo! Finance's survey of 10 analysts who have an average price target of $142.30 per share.
However, our own FCF analysis, in our prior article, shows that GOOG stock could be worth as much as $217.88 per share.
The bottom line is that using either a P/E metric formula or a FCF formula it clearly looks like GOOG stock is worth much more than today's price. That makes it attractive to value investors who own GOOG stock for the long term.
One way to conservatively play this upside in the near term is to sell short out-of-the-money (OTM) put options. This helps lower buy-in costs if the puts are exercised as well as to gain extra income.
After all, Alphabet still does not pay a dividend. So, by both holding GOOG stock and shorting OTM puts, investors can gain the best of both worlds: GOOG stock's upside potential as well as current income.
Shorting OTM Puts
For example, in our last article, we discussed selling short the Aug. 25 expiration $130 strike price. At the time, on July 30, the premium received from this trade was $2.76 per put option sold short. Today, those puts are lower at $1.19. So, that trade has been successful.
It might make sense to roll this trade over and short it again for a further expiration period. That involves buying back the shorted put option (i.e., “Buy to Close”) and then entering another order to “Sell to Open” a new put trade.
For example, the Sept. 15 expiration put option chain, a little over 3 weeks from now, shows that the $126 puts trade for $1.81 per contract. That means that the short seller gains an income of 1.44% at a strike price which is 3.50% below today's price.
This means that a trader who secures $12,600 in cash and/or margin with their brokerage firm can enter an order to “Sell to Open” 1 put at $126.00 for Sept. 15 expiration. The account will immediately receive $181.00 in it. That shows that there is an immediate yield of 1.44% (i.e., $181/$12,600).
This shows that investors can conservatively play the upside in GOOG stock today. This strategy works best when an investor both owns the stock and also shorts OTM puts. Even if the stock price falls to $126.00 or lower on or before Sept. 15, the investor can potentially lower their buy-in cost.
In addition, they still get to keep the income that was generating selling the OTM puts. This makes this kind of trade profitable, especially if it is repeated continuously.
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.
