Alphabet’s Stock Is Ready To Soar

Michael Kramer and the clients of Mott Capital own GOOGL

Alphabet Inc. (GOOGL), the parent of the search engine Google, closed at an all-time high on November 7. The big news, shares broke out of a roughly 18-month period of consolidation, which may result in the stock soaring in the months ahead. Even from a valuation perspective the equity is historically cheap and could see significant multiple expansion in the months ahead.

Shares fell initially after the company reported third quarter results at the end October on an apparent miss on the bottom-line, while reporting better than expected revenue. When digging deeper the earnings miss was due to a non-operating item on the income statement. The results were better than they appeared, and the operating income was stronger than the previous year.

Breaking Out

Alphabet closed above $1,300 for the first time on November 7, potentially setting up a big move higher for the stock. Over the course of the past decade the stock appears to trade with a very similar pattern, which is one where the equity rises significantly and then consolidating for a long period. Based on those patterns the stock could be setting up for its next significant long-term move higher.

Valuation Is Reasonable

One reason why the shares may finally be moving up is that the valuation of the equity is reasonable given its historical trends. Historically the stock has traded in a range of 16.5 to 26.5 times one-year forward earnings estimates. If the stock returns to the upper end of its historical range at 26.5 from its current 23.9, then the shares could trade for roughly $1,430.

That valuation isn’t far off from average analysts’ price targets on Alphabet. Currently, 44 analysts cover the stock, and they have an average price target of $1,441, which is about 10.3% higher than the current stock price of around $1,305 on November 7.

Results Were Better Than They First Appeared

However, despite the stock’s big advance, shares fell following the company’s third quarter results. That is because the company reported earnings of $10.12 per share, which was below estimates of $12.42. However, when digging through the company’s income statement the big earnings miss was driven by a sharp decline in equity securities, which fell by $1.5 billion. That resulted in other income falling by $549 million, and a decrease in net income to approximately $7.1 billion versus roughly $9.2 billion the year before. But interestingly, without the sharp declines in the equity portfolio, operating income was better than the prior year at $9.2 billion versus $8.6 billion.

Investors seem to be recognizing that Alphabet’s results were better than they initially appeared. As a result, the stock may now be breaking out of his 18 month period of stagnation.

Michael Kramer is a financial market strategist and the portfolio manager of the Mott Capital Thematic Growth Portfolio.

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