Mark R. Hake, CFA
6 min read
In This Article:
Alphabet Inc. (GOOG) generated strong Q1 free cash flow (FCF) that was higher than expected. Moreover, its stable FCF margins, despite higher capex (capital expenditure), imply GOOG stock is worth 19% more at $212 per share. Shareholders can make extra income by selling short out-of-the-money (OTM) puts.
GOOG closed at $178.27 on Friday, June 27, up +2.20%. It is still off its highs from early February. But it still has more to go. This article will show why and how to play it.
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Alphabet's Strong Free Cash Flow Makes GOOG Stock a Value Buy
I discussed GOOG stock's value in a Barchart article two months ago on April 27, after its Q1 results, “Alphabet's FCF Results Are Better Than Expected - Time to Buy GOOG?”
Alphabet produced almost $19 billion in FCF last quarter and about $75 billion over the trailing 12 months (TTM). That was despite significantly higher capex spending, mostly on its AI-driven capital spending.
For example, in Q1, capex represented 47.5% of its operating cash flow (i.e., $17.2b/$36.15b), up from just 36.6% in Q4. This can be seen in the table in my April 27 Barchart article.
More importantly, however, its FCF margins are still very strong (i.e., FCF as a percent of revenue). For example, in the trailing 12 months (TTM), FCF represented 20.8% of TTM sales:
$74.78 billion TTM FCF / $359.7 billion TTM sales = 0.208 = 20.8% TTM FCF margin
That was close to the Q1 FCF margin rate of 21.0%:
$18.95 billion Q1 FCF / $90.234 billion Q1 sales = 0.21 = 21% Q1 FCF margin
In other words, Alphabet is still gushing the same amount of cash from sales directly into its checking account despite higher spending on servers, data centers, and AI-driven items.
That helps set a higher valuation for Alphabet.
For example, analysts project $387.81 billion in revenue for 2005 sales and 2006 is +10.6% higher at $428.88 billion.
That means, on a run rate basis, the next 12 months' (NTM) revenue is expected to be $408.4 billion. Now we apply a 22% average FCF margin (i.e., FCF margin rises by 100 basis points):
$408.4 billion NTM sales x 22% FCF margin = $89.848 billion FCF NTM
That is almost 20% higher than its last 12 months:
$90b / $75b = 1.20 -1 = +20%
This could push its present valuation higher. Let's see why.
