Wednesday, 5 April 2017

Are Tech stocks Value stocks? (i) Alphabet Inc (NYSE:GOOG): Part 2: Quantitative Factors

So given all my qualitative analysis does Alphabet / Google offer an attractive intrinsic value to the investor.

The answer presently is no.

I think Google shares are worth around $700 to $800 a share on the basis of my analysis factoring in a slowing growth rate and relatively stable margins

My key assumptions are revenue growth slows to 17% this year and slides down to 8% by 2022. Operating margins are 25.7% this year sliding down to 24.2% in 2022. This means earnings growth CAGR declines from 18.1% to 11.2% by 2022.

Amiable Minotaur Alphabet Model: Revenue Growth assumptions

All these are still really positive numbers because Google is still really a maturing growth stock. These numbers are not the highest but they give some margin of safety for future uncertainly. [The actual path is likely to involve a recessionary dip but the timing is highly uncertain.]

I also assume Google invests around 11% of sales as Capex (roughly inline with the recent period) and commences a 30% payout dividend from 2018.

With a DCF valuation on this basis at a WACC of 8.17% (Ke 8.5%, debt 3%, debt 5% of capital) and a 5% FCF growth rate 2023 fading to 3% by the terminal value. I get a fair value at $802 a share.

Now a dividend discount model of that 30% payout - $10.73 in 2018 - I am suggesting (I doubt Google will actually do this) with a pretty good 6% long term growth rate suggests a value of $429 a share. Still that dividend could be higher - but Google would have to pay out 70% of earnings to reach the current share price value of ~$850 a share. Unlikely to happen anytime soon given they currently pay no dividend - this is just another guideline valuation.

Now I might pay 20x 2018E P/E for Google given the earnings growth rate remains fairly high ~15% in that period. That gives a value of $715. 

What all this adds up to is I struggle with fairly conservative numbers to find value above $800 a share for Google. Now as a value investor I want to buy a stock below the intrinsic value not at or above intrinsic value. Many would argue my numbers are too conservative. That is a valid argument as Google is still really a growth stock and to buy growth you have to be a believer. But I think generally US stocks are expensive at the moment, the Shiller PE is about 28x and the long run average is 16x. This calls for extreme caution when adding stock to the portfolio vs holding cash.

I would buy Google were it to fall to around the $600 a share mark (>25% down from today) because I think it has a great moat. Providing it did not fall below that mark due to the loss of its moat. 

Tactically I would be a buyer of Google around that level which would likely come about when the current bull market ends and a broad cyclical downturn/recession based selloff gives me a chance to buy the stock at a more attractive level. 

I think Google is indeed very cyclical - it slowed down a lot in 2009 at an earlier stage of growth. If another slowdown comes the selloff could be strong giving a buying opportunity. 

At this point I can't see value in the price even though Google has a great business. But the impulse behind my analysis was more to see if I want to buy Google in future and at what price so that should a selloff occur I have the research ready to go.

Disclaimer: I have no interest in Alphabet shares at present. These are opinions only, not investment advice. If in doubt read my disclaimer. 

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