Even With a Split, It’s Not a Good Time to Buy Alphabet Stock

Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) stock has been a life-changer for many investors. However, the market always corrects itself, and that’s why you’ll see asset, sector and industry rotations happen repeatedly. That might be a reason to avoid GOOG stock for now.

Alphabet Inc. (GOOG, GOOGL) and Google logos seen displayed on a smartphone

Source: IgorGolovniov / Shutterstock.com

There’s a quote often attributed — though not credibly sourced — to Thomas Jefferson: “With risk comes great reward.” Needless to say, you need to take risks to receive a return as an investor. However, the risk-reward profile of a stock needs to be analyzed carefully, because there’s a difference between justifying risk and betting big without understanding what you’re getting yourself into.

After examining Alphabet’s stock tranches, I’ve discovered that its risk-return profile isn’t well placed at the moment; here’s why.

Possible Return to Shareholders

First off, let’s look at matters from a quantitative vantage point. To determine GOOG stock’s estimated return for the year, I made use of the capital asset pricing model (CAPM), which is a statistical regression that factors in the stock’s sensitivity to the broader index (beta), the stock market’s risk-premia (equity risk premium), and the U.S. 10-year Treasury yield (risk-free rate) to justify a baseline price target for the stock.

It may seem surprising to many that GOOG stock has an expected return of only 8.1% considering we’re talking about a stock that’s surged by more than 200% during the past five years. However, the stock’s growth has naturally slowed down as the tech industry, and Alphabet alike has traversed into maturity.

Beta 1.02
Risk-Free Rate 1.98%
Equity Risk Premium 6%
Expected Return 8.1%

I proceeded to factor the stock’s Expected Return into the Sharpe Ratio metric, which measures a stock’s return relative to the broader market volatility, otherwise known as standard deviation. Although Alphabet’s Sharpe Ratio of 1.098 remains acceptable, it’s decreased by 6.53% year-to-date, suggesting that you’ll be invested in a stock that provides a worse risk-return profile than it did when the year started.

I’ve never been a fan of using statistical methods in isolation. I’ve worked with various fund managers that are purely model-driven but fail to incorporate common sense. So here’s my 2 cents on the broader picture. It’s clear that Alphabet has turned into a powerhouse with a significant market stronghold; however, it’s also visible that the market isn’t very “tech-friendly” at the moment.

I don’t see large-cap investors banking on a stock such as Alphabet when they could be buying energy or mining stocks at approximately half of book value with dividend yields surplus of 5%. In a nutshell, I believe that the market runs on an equilibrium thread and that Alphabet’s bull run during the past decade will be met with investor rationalization during the next decade.

But What About the GOOG Stock Split?

Alphabet announced in February that it has committed to a 20-1 stock split of its class A-, B-, and C-Shares. The common narrative is that the stock will be more affordable to retail investors and, in turn, be in high demand, thus surge higher in the near to medium term.

I can confirm to you that this theory is a myth; let me explain why. Approximately 10.4% of the firm’s stock is held by “affordable” exchange-traded funds, meaning that exposure to the stock has long been available to investors who aren’t willing to fork out north of $2500 on a single stock.

Furthermore, a Cambridge University-published study discovered that stock splits only lead to excess returns of 3.38% on average because investors tend to ascertain their analysis of the asset’s future performance rather than its affordability. I’d thus have to support the evidence and conclude that a stock split won’t be enough to cause a surge in Alphabet’s stock price.

I’m not saying that Alphabet isn’t a quality company. I mean, you’d have to be fishing for reasons to conclude that. Instead, my argument is that GOOG stock doesn’t possess the same risk-return profile as it did in the past. An expected return of 8.1% is lower than most safe-haven assets, while a year-to-date Sharpe Ratio decline of 6.53% leaves much to be desired for. The announced stock split could add some short-term hype, but it’s evident that stock splits’ linkage to price appreciation is a folk tale.

On the date of publication, Steve Booyens did not hold any position (either directly or indirectly) in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Steve co-founded Pearl Gray Equity and Research in 2020 and has been responsible for institutional equity research and PR ever since. Before founding the firm, Steve spent time working in various finance roles in London and South Africa. He holds an MSc in Investment Banking from Queen Mary – University of London and is working towards his Ph.D. in Finance, in which he’s attempting to challenge the renowned Fama-French 5-factor pricing model by incorporating ESG factors. His articles are published on various reputable web pages such as Seeking Alpha, TipRanks, Yahoo Finance, and Benzinga. Steve’s articles on InvestorPlace form an interesting juxtaposition between mainstream opinion and objective theory. Readers can expect coverage on frequently traded stocks, cryptocurrencies, crowdfunding, and ETFs.


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