Monday, 26 October 2015

For the first time I am selling some Google (Alphabet) stock

Do I hear US$500 a share?  How about US$600?  Still interested?  Well how about US$700 every Alphabet (aka Google) share?  In fact to be precise, as per the Friday close for the 'GOOG' ticket unit, US$702 a share.

It has been a great run for Alphabet/Google shareholders over the last year.  I have liked the stock for the totality of 2015 (and before) but the pushing through the US$700 share price level even makes me wonder.

So what should you do with Alphabet shares above a US$700 share price?

First, let's look at the Q3 numbers and try and work out why the market marked up the stock so aggressively after the close Thursday.

Headline revenue growth was nothing special...although FX influences (as with for so many companies) were a negative.  Still headline 13% year-on-year was not too shabby...

...and non-GAAP income was up 15% to a new quarterly record.  Not exactly bad metrics for a near US$500bn market cap company.  

As regular readers will know I tend to look at the combination / gap between the 'paid clicks' and the 'cost-per-click' to give some real underlying insight.

So how did the numbers look this time?

Q314 17% (paid clicks) -2% (cost-per-click) = 15%
Q414 14% -3% = 11%
Q115 13% -7% = 6%
Q215 18% -11% = 7%
Q315 23% -11% = 13%

The best quarter of the last four!  Again not too shabby for a company with a near half a billion dollar market cap. On the conference call management attributed much of this improvement down to YouTube.

And how about cash flows which I have waxed lyrical about at both of the links above?  Well, US$3.6bn is good although not as strong as the previous two quarters.  Nevertheless the cumulative last four quarter free cash flow equates to just over US$14.6bn or 3% of the current market cap.  Not shabby...but a combination of a slight fade in the quarter-on-quarter free cash with the aforementioned rise in the company's market cap has meant those previous hopes of getting near the fabled 5% free cash flow yield have been dashed.  Blame the clear return to a double digit growth potential...(a growth level which really should not be anywhere near a 5% free cash flow yield of course).

But Alphabet/Google were not finished there.  As Fast FT noted:

'Alphabet, the new holding company for Google, has announced the group's first stock buyback - and got clever with it.

In a play on its new corporate name, the company announced that it's stock buy-back would amount to $5,099,019,513.59 - or the square root of 26, the number of letters in the alphabet.

The numerical gimmick echoed a stock offering it mounted a year after its IPO a decade ago, when it sold 14.159m shares, using the numerals after the decimal point in pi'. 

Given the company currently has approximately US$60bn of net cash and is generating cash as per the above this clearly is easily funded, sensible and a shareholder friendly approach - and surely only the start at little more than 1% of market cap.  As I noted in July:

'...with the new CFO mentioning twice the notion of ‘maximising stakeholder value’ on the conference call I strongly reiterate my earlier call on the paying of a dividend or buying back stock (and maybe both). Yesterday’s coy comment of it being ‘premature…to gauge how capital return fits in’ is unlikely to be repeated beyond the end of this year'

What else did management say/do?

Well, 'new Google CEO Sundar Pichai states Google has indexed over 100B deep links within 3rd-party apps, as it tries to head off the threat posed by mobile users bypassing search in favor of going directly to apps. 40% of mobile searches now have in-app results within their top 5 results. Pichai reiterates mobile now accounts for over 50% of searches. He also notes over 20M Chromecast devices have been sold to date'. 

I also note positive conference calls comments like:

UsersProducts like Search, Android, Maps, Chrome and YouTube each have over a billion users already, and Google Play crossed that milestone this quarter as well

Android opportunities: Especially, there are whole new markets opening up, there’s next billion users coming online in emerging markets. And businesses, I mean, Enterprises, a whole opportunity for OEMs as well. So I think there is a lot of room ahead.

Digital shift: top 100 advertisers spend was up 60% year-on-year on YouTube

So not much to dislike in the Alphabet conference call and lots of residual growth scope...but what about valuation today?

Extrapolating the non-GAAP operating income puts the stock on around a prospective x17 EV/ebit multiple which is high but not totally unworkable.  Of course these are the non-GAAP similar analysis on a GAAP basis and it throws out nearer a x19 multiple.  Still growth is better and they are starting to return cash...and then there is the dynamic aspects of creating Alphabet.  

You can go around this valuation debate forever.  My summary view is to take a few profits north of US$700.  Alphabet sits in the middle of so much but the scope for a share price appreciation pause as seen in 2014 is high.  And that smells like a big top-slice opportunity for me. 

For the first time I am going to sell some Google stock from my pension fund. 

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