Alphabet (NASDAQ:GOOG) has recently reported a remarkable 73% year-on-year increase in its free cash flow (FCF) for the second quarter, soaring from $12.59 billion to an impressive $21.778 billion. This substantial growth is even more noteworthy when compared to its Q1 FCF of $17.22 billion, marking a significant 26.5% increase. Despite a recent surge in Google stock prior to the earnings release on July 25, its current value of $133.01 as of July 28 is still considered undervalued given the company’s robust financial performance.
The surge in free cash flow presents a compelling income strategy for long-term GOOG stockholders. With Alphabet not paying dividends, investors have found success in buying long-term call options and shorting near-term out-of-the-money put options. Additionally, Alphabet’s consistent share buybacks demonstrate the effective use of free cash flow, benefiting the company in the long run.
The importance of Alphabet’s powerful free cash flow lies in its ability to fund extensive buyback programs and other discretionary expenses, such as acquisitions. However, the current valuation of Alphabet does not fully reflect the strength of its cash flow. When annualizing the Q2 FCF of $21.778 billion, it results in a noteworthy 5.1% FCF yield, outperforming comparable stocks like Microsoft (NASDAQ:MSFT).
For instance, Microsoft reported approximately $19.8 billion in FCF for Q2, resulting in a lower FCF yield of 3.15% based on its market capitalization. By comparing this FCF yield with Alphabet’s, it becomes evident that GOOG stock should be valued higher. Dividing GOOG’s annualized FCF of $87.1 billion by the FCF yield from MSFT, a market cap of $2,765 billion is estimated, signaling a potential 67% increase from its current market cap of $1.689 trillion.
As a result, GOOG stock could potentially reach $217.88 per share, presenting a substantial increase from its current value of $133.01. Traders can leverage this target price to engage in profitable options trades.
For bullish traders anticipating a 67% rise in GOOG stock to $218 over the next year, investing in call options with a reasonable premium becomes an attractive option. For instance, the Nov. 17 call options with a $155 strike price, which is 16.5% above the current spot price, trade at just $2.02 per call. With the breakeven price at $157.02, the call option becomes a worthwhile investment, especially if GOOG stock reaches the target price of $217.88.
Complementing the long call option strategy, shorting out-of-the-money put options can generate income. By selling put options with a lower strike price, investors can utilize the generated income to fund the purchase of long call options, effectively reducing the overall cost and minimizing downside risk.
To execute this strategy, investors can secure funds by shorting one put contract at the $130 strike price, generating a yield on their investment. The income from the short put play can then be used to purchase a call option, rendering the call option purchase “free and clear.”
Google Stock Undervaluation Makes it Attractive
In conclusion, Google stock’s undervaluation in light of its robust free cash flow presents excellent opportunities for investors to capitalize on its potential growth. By implementing well-thought-out options strategies, investors can attain significant returns while effectively managing risks. The powerful free cash flow of Alphabet reinforces its position as an attractive investment choice for those seeking long-term growth and value in the market.
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