The FANGs have hit a wall of late. Alphabet Inc (NASDAQ:GOOGL) and Facebook Inc (NASDAQ:FB) have inched ahead by less than 1% over the past month, while Amazon.com, Inc. (NASDAQ:AMZN) is down 1% and Netflix, Inc. (NASDAQ:NFLX) has dropped more than 3%. It’s far from disastrous, but it’s not encouraging either — and if nothing else, it’s certainly a divergence from their otherwise go-go performance in 2017.
Of particular interest to me right now is GOOGL stock, which is one of my favorite FANG positions.
Let’s jump in.
A Look Under the Hood
Alphabet is more interesting than concerning right now in large part because this appears to be more market rotation than fundamental business issue.
The search giant is coming off a better-than-expected second-quarter report, with earnings per share topping estimates by more than 10%, and revenues climbing above the consensus by about 2%. Better still, sales increased 21% year-over-year — robust growth for what is currently a $650 billion company with an annual top line of $90 billion.
Search remains strong, thought traffic acquisition costs as a percentage of ad revenues did tick higher, from 21% to 22%. YouTube is doing well, and is working on growing its YouTube TV offering. Alphabet’s Waymo business is now being valued at $70 billion by some analysts — a figure that could climb as it makes more advances in the still-budding self-driving industry.
In short, business is good. But the valuation on GOOGL stock could be an issue.
Alphabet and Facebook have been my favorite FANG stocks for some time in part because of valuations. While Amazon and Netflix no doubt will play significant roles in our lives for decades to come (and while I wish I had bought years ago), it’s difficult to get on board when they’re trading at high-double-digit to low-triple-digit multiples to future earnings.
It’s not the same situation with FB and GOOGL, which not only have tangible results but also have more grounded valuations. Clearly, the market still believes in these companies, but they’re also being realistic.
But that doesn’t mean they’re priced perfectly.
A Closer Look
Analysts remain pretty optimistic about Alphabet’s business going forward, expecting revenues to grow 21% in 2017 and 17% in 2018. Because of an adjustment in how GOOGL is reporting earnings (GAAP vs. non-GAAP to account for stock-based compensation — a significant expense in Silicon Valley), earnings power looks diminished in 2017.
That’s not really the case. In reality, Alphabet will continue growing earnings at an impressive clip for a number of years. And given the stock’s 20% rally this year, it’s clear investors understand this conversion.
However, GOOGL stock now trades near 35 times earnings — not astronomical, but certainly higher than the stock’s five-year average price-to-earnings ratio of 29. That could be causing some hesitation, and perhaps for good reason. Alphabet has had difficulty maintaining a P/E anywhere north of 35. It tends to bounce near 27 and top out near 35.
A return to its five-year average would require a more than 15% decline in the stock, from about $950 to about $800. That seems difficult to fathom in the midst of such a strong-running bull market, but remember that GOOGL traded at $750 just nine months ago.
A decline to this level surely would be a buying opportunity, though I don’t have much confidence such a fall with materialize. Alphabet could achieve such a valuation over time by simply remaining flat and earning more, with its P/E “catching up.”
Bottom Line on GOOGL Stock
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Of course, the more times a stock tests a level, the more likely it is to break.
An eventual fail of $920, if it occurs, would send shares at least down to the $890 level, where the 200-day moving average currently rests. (This also is where the stock broke out from in April.) A broad-market downturn could easily send shares to that level, and perhaps even lower.
You can hold out hope for a decline to $800, where shares would be a real steal, but I think you’d be left at the altar. Instead, consider a decline to $890 to be a prime opportunity to buy a premium company at a slightly-less-than-premium price.
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter at @BretKenwell. As of this writing, Bret Kenwell did not hold a position in any of the aforementioned securities.
