Alphabet Inc (GOOG, GOOGL) stock is down 5% in 2016, underperforming both the S&P 500 (+3.6%) and the Nasdaq (-1%) in 2016.
Weighing on the search giant has been a constant back-and-forth with European Union regulators, who think GOOGL isn’t playing fair in Europe. In April, the company was hit with its second antitrust case from the EU, and this one — which involves its popular Android mobile OS — could get expensive.
GOOGL made $11 billion from ad sales on the Android last year alone.
That doesn’t seem to irk Morgan Stanley, which raised the price target for GOOGL stock from $850 per share to $865 per share today. That implies more than 18% upside from Alphabet’s $731.09 closing price yesterday.
Let’s take a look at just how feasible a rally like that would be:
GOOGL Stock: Multiple-Dependent
Can Alphabet really go on an 18% rally anytime soon? Sure, it’s down 5% in 2016, but over the last year it’s actually up 37%.
The decision to reorganize the company formerly known as Google into Alphabet was cheered by the markets, quarterly results repeatedly impressed and Wall Street continued to reward this performance with ever-higher multiples for GOOGL stock.
A year ago, Alphabet traded at 25 times earnings, which is still somewhat aggressive for a company the size of Alphabet, which analysts expect will grow earnings per share by 13% in 2016 and 18% in 2018.
Its PEG ratio, which compares the price-to-earnings ratio to the growth rate, sits at 1.34 — it’s not the worst reading I’ve ever seen but it doesn’t exactly make GOOGL a screaming buy either. When the PEG is below 1, typically you’ve got an undervalued stock on your hands.
While analyst price targets are usually meant to be for one year, it’s easier — and a little more interesting — to look at projected EPS figures, then multiply those by a range of potential multiples (P/E ratios) to get a range of feasible future stock prices.
That’s precisely what we’ll do. Using EPS estimates for 2017, we can plug in a number of multiples to see where Alphabet should be trading on Dec. 31, 2017:
- FY 2017 EPS Estimate: $39.66
Multiples:
- Trailing-12-month P/E of Dow Jones Industrial Average = 19.15
- TTM P/E of the S&P 500 = 24.22
- GOOGL P/E one year ago = 25.39
- GOOGL Current P/E = 30.08
Implied price of GOOGL stock on Dec. 31, 2017 at various multiples:
- TTM P/E of Dow Jones Industrial Average = $759.49
- TTM P/E of the S&P 500 = $960.56
- GOOGL P/E 1 Yr. Ago = $1,006.97
- GOOGL Current P/E = $1,192.97
- Average of all scenarios = $980 (+34% upside to yesterday’s closing price).
- Assuming GOOGL misses EPS by 10%: $882 (+20.6% upside to yesterday’s closing price).
After taking inventory of all these scenarios, it seems that Morgan Stanley’s $865 price target for GOOGL stock isn’t quite so unreasonable after all.
It’s tough to see GOOGL trading for the same multiple as the average member of the Dow Jones Industrial Average, and it likely deserves a premium to the S&P 500, too.
But even if we get conservative and assume consensus 2017 EPS figures are 10% too high, and we average all the likely multiple scenarios, we get a fair value for GOOGL stock of $882 at the end of 2017, or a 20% upside from here. That’s not such a bad return in a year and a half.
As of this writing, John Divine did not hold a position in any of the aforementioned securities, but he’s starting to think that he should. You can follow him on Twitter at @divinebizkid or email him at editor@investorplace.com.
