Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) reported a 3.9% lower operating income and a 3.6% lower pre-tax income for Q1 2020. But GOOG stock has risen even further and is now more expensive. The stock now trades for almost 32 times its 2020 earnings prospects, according to Seeking Alpha estimates.
However, those same estimates show a huge increase in earnings set for 2021. Earnings per share (EPS) may hit $56.56, up $12.26, or almost 27.7% expected for 2021. That puts the stock just 25 times 2021 forward earnings.
How High Could GOOG Stock Rise?
I say “just,” because this is a low price-to-earnings (P/E) ratio for GOOG stock. For example, last year Alphabet earned $34.66 per share fully diluted on a normalized basis. The stock ended the year at $1,337.02 per share. This gave the stock a forward price-to-earnings ratio of 38.6 times.
Therefore, using that P/E ratio with the 2021 forecasted EPS of $56.56, GOOG stock could potentially hit a price of $2,183.22 per share. That represents a potential gain from today (May 22, 2020), with the stock at $1,410.42, of 55%.
But will the stock really be worth 38.6 times earnings? Maybe, but margins would have to increase to the same levels as in 2019. Last year, the company made a net income margin of over 21.2%. This is higher than its most recent quarterly net income margin of just 16.6%.
Adjusting the Stock Valuation For Margins
Without those higher margins, it is doubtful the GOOG stock would achieve the higher P/E ratings from analysts. Right now the analysts who collectively are predicting $56.56 per share in EPS for 2021, are assuming a net income margin of about 19%. That is about halfway from the present margin to last year’s margin.
Right now, GOOG trades for 31.8x 2002 expected earnings. Therefore, I suspect the stock will trade for half the rise in P/E ratio with its 2021 ratio of 38.6 times. That puts its value at 35.x times its expected earnings in 2021 of $56.56 per share, or $1,990.91 per share.
Adjusting for expected margins, GOOG stock is worth about 41% more if the stock hits its margin and EPS targets in 2021.
Analysts Seem Uniformly Bullish on GOOG Stock
Barron’s just ran an article on how bullish analysts are on Alphabet. The article says Wall Street expects many years of double-digit earnings growth for the company.
The thesis is that more companies will rely on digital advertising for their market and growth drivers. As I pointed out in my article, Google and Facebook (NASDAQ:FB) dominate this portion of the advertising market. Digital ads are taking over the whole advertising market.
Barron’s referred to a Citigroup analyst who projects earnings of $55.43 per share in 2021, including a 20% growth in revenue. The analyst then projects EPS of $72.28 per share in 2022.
Even using a lower P/E ratio of just 32 times EPS, that scenario still projects a stock price of $2,312 by 2022. That represents a potential gain of 64% for GOOG stock. It also gives Alphabet a massive market value of $1.58 trillion.
Should You Buy GOOG Stock Now?
Betting on Alphabet is almost like betting on a rebound in the world economy. This is because as companies recover in their businesses, and as there is more consumer discretionary income, the propensity of businesses using advertising rises. This relates directly to the digital advertising business, which is also gaining market share.
I suspect that an investment in GOOG stock will likely do well over the next several years, despite the high price-to-earnings valuations.
Recently a famous hedge fund investor, Seth Klarman, who runs Baupost Group, decided to make $350 million investments in both Alphabet and Facebook. This a great vote of confidence in both companies. He probably recognizes that the stocks are at bargain prices compared to their future valuations.
I suspect that investors who follow his lead in GOOG stock are likely to make money as well.