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Alphabet Class A (GOOGL) stock is showing large unusual put option activity today based on a Barchart report. The puts are set to expire after Friday, which looks to be due to short-term trading activity.
The Barchart Unusual Stock Options Activity Report on Wednesday, Dec. 20, 2023, shows that over 26,400 contracts of $140 strike price puts expiring Dec. 22 have traded today. In addition, over 15,400 puts at the $139 strike price for the same expiry period have also traded.
GOOG stock trades for $140.60 per share, so these puts are only slightly out-of-the-money (OTM). If the stock were to decline just slightly to $140.00 or $139.00, i.e., by -0.43% or -1.13% respectively, the short-sellers of these puts will have to buy a large number of shares in GOOGL stock.
For example, the potential obligation of the $140 short-put sellers will be over $369.6 million (i.e., $140 x 26,200 contracts x 100). The traders would most likely cover their obligation in that case.
Note that this volume of puts is significantly higher than normal. For example, the Vol/OI (i.e., Volume/Open Interest) column shows that the $140 puts are over 140x the prior number of outstanding put contracts. The $139 strike price puts are almost 100x normal.
As a result, these short-term trades are likely from large institutional accounts or hedge funds.
This could also be a situation where a long investor(s) is hedging their long position in GOOGL stock. They may have purchased a large number of put contracts for expiration on Friday. In both tranches, they are hoping that any decline in the stock will be offset by a rise in the price of the puts.
What can we glean from these trades? Let's look at the valuation issues relating to GOOGL stock and see where things stand.
Where Things Stand with Alphabet and GOOGL Stock
Like most tech stocks, GOOGL has risen a good deal in the past month. The chart below from Barchart shows that it is at a recent 6-month peak.
Fears of a reversal could be one more reason why institutional funds might want to buy puts to protect against any downside from here.
But from a valuation standpoint, Alphabet stock still looks relatively inexpensive.
For example, analysts surveyed by Seeking Alpha show that they expect $6.70 in earnings per share (EPS) next year, up over 16% forecast for 2023 (i.e., $5.77 EPS).
That puts GOOGL stock on a 2024 forward earnings multiple of just 20.8x. That is not expensive given that Morningstar reports that its 5-year forward P/E (price/earnings) multiple has been 25.13x.
In other words, based on that measure, GOOGL stock could be worth as much as $170 per share sometime in the next year. That implies it has a 21% upside over today's price.
FCF Looks Strong
Moreover, from a free cash flow (FCF) standpoint, the stock looks cheap. Alphabet is one of the few companies that publishes its FCF every quarter. On page 9 of its earnings release, the company stated that in Q3 it made $22.6 billion in FCF.
That FCF represents 32.7% of its quarterly revenue of $69.09 billion. In other words, almost one-third of all its revenue goes straight into its bank account with no obligations whatsoever.
Free cash flow is the remaining leftover or “free” cash flow after all cash expenses and spending such as capex and working capital changes. It's a measure of the company's profitability.
As a result, if we use analysts' projections of $340 billion in revenue next year, we can estimate that Alphabet will generate over $111 billion in FCF. We can use that to value the stock.
For example, using a 3.33% FCF yield, the stock would rise to have a $3,369 billion valuation. That assumes that all the $111 billion in FCF is paid out as a dividend and the stock market gives GOOGL stock a 3.33% dividend yield. So we divide $111b by 0.0333 and derive a target market cap of $3.369 trillion.
That is also the same as multiplying its FCF by 30 times (i.e., 1/0.03333 = 30). This is reasonable given that its long-term P/E multiple is 25x.
In other words, given that its market cap today is $1.72 trillion, we could see GOOGL stock rise by 96% over the next year.
The bottom line is that GOOGL stock is undervalued anywhere from 21% to 96%. So, on average it's possible the stock could be worth 58.5% more over the next year. That means that most shareholders in the stock should probably hang on, despite the stock's recent rise.
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.
