In light of the size and dominance of Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) stock, the performance of GOOGL stock last year was impressive. In 2019, the owners of GOOGL stock enjoyed a return of 30%. Aside from a sharp dip near the end of April, the shares for the most part steadily marched higher.
Just as impressive is the recent momentum of the stock. Despite the new year being so young, GOOGL stock is already up nearly 7% in 2020. As a result of its steady-as-she-goes journey, Alphabet is now on the verge of attaining a market capitalization of $1 trillion. That’s a significant benchmark, but some on the Street are still criticizing GOOGL stock.
Recently, CNBC’s Jim Cramer poured some cold water on the rally, declaring bluntly that he doesn’t “like this move.” According to the popular Mad Money host, the upward trajectory of the shares is “based on nothing fundamental, just the momentum that we see in so many tech names.” Cramer also cautioned against buying other large tech names like Microsoft (NASDAQ:MSFT), Apple (NASDAQ:AAPL) and Facebook (NASDAQ:FB).
It’s not hard to see why he’s skeptical of GOOGL stock and its large technology peers. Once a stock clears a key psychological threshold like $1 trillion, investors ask questions like, what’s next? Arguably, most of Alphabet’s fundamental drivers are well-known.
For instance, bulls can discuss the internet giant’s dominance in search engines and digital advertisements. Yet after hearing the same narrative about Alphabet for many years, investors may want to seek stocks with fresher stories.
And that’s why Cramer warned investors about Alphabet’s upcoming earnings report. If GOOGL can’t deliver very impressive results, its shares could fall tremendously. But is he right about the need to avoid Alphabet or does GOOGL stock have room to run?
GOOGL Stock Isn’t Flying Way Above Alphabet’s Fundamentals
Central to Cramer’s argument is that GOOGL stock – along with the shares of the other big, high-flying tech firms – have decoupled from their underlying companies’ fundamentals. As a result, merely good earnings reports may not justify their currently elevated valuations, Cramer believes.
But have the shares of Alphabet overshot its fundamentals? After looking at the data, I’m not entirely on board with Cramer’s assessment.
In 2004, the year of Alphabet’s initial public offering, the company reported sales of $3.2 billion. For fiscal 2019, the company is on track for revenue of $155 billion, a simply massive gain.
Similarly, in 2004, GOOGL stock was trading at an average price of $79.82. Last year, it averaged $1,195.81.
The correlation coefficient between GOOGL stock and Alphabet revenue is 99.2%. There really can’t be a stronger correlation than that: as Alphabet’s top-line sales have moved higher, so has its share price.
Click to Enlarge
I discovered that the correlation between the company’s revenue and its stock price has gotten stronger in recent years. Between 2004 and 2011, the correlation coefficient was nearly 84%. But from 2012 through 2019, the metric increased to 99.2%.
I’m not trying to bore you with math. But I’m bringing these figures up to contend that GOOGL stock has not really decoupled from its fundamentals. It’s true that, since 2012, Alphabet’s year-over-year revenue growth rate has declined due to the law of large numbers. But the same thing has happened to the year-over-year average gains of GOOGL stock.
In other words, the law of large numbers is also impacting Alphabet’s shares, which is exactly in-line with expectations. On average, the price of GOOGL stock has moved in accordance with the company’s revenue trends.
One Caveat to Consider
Still, that doesn’t mean that Cramer’s warning is completely without merit. I can see why the elevated price of Alphabet stock may worry stock market observers.
As I mentioned above, the average price of GOOGL stock in 2019 was $1,195.81. That was up 6.4% from the prior year’s average price. However, yesterday Alphabet stock closed at $1,430. That’s about 28% above its average price of 2019.
That’s a big difference. Not only that, but if Alphabet finished 2019 with sales of $155 billion, that would be 13.3% above its 2018 sales. In that case, one can make the argument that GOOGL stock is indeed getting ahead of Alphabet’s fundamentals.
Therefore, investors who are worried that Alphabet’s stock has gotten too expensive may want to hold off on buying the shares. Technically, GOOGL stock is overheated at the moment. However, it hasn’t reached irrational territory. If the shares drop, investors can press the “Buy” button without any hesitation.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.
