Value Buyers are Watching Google Stock for a Rebound in January

Alphabet (GOOG) stock fell about 39% last year, including a decline of 7.68% in December. As a result, value investors are looking for a rebound in GOOG stock. After all, analysts expect higher earnings in 2023 and its multiple is well below its historical average.

For example, 44 analysts surveyed by Seeking Alpha forecast $4.77 in earnings per share (EPS) for 2022 and project $5.31 for 2023, an increase of 11.3%. Since GOOG stock closed 2022 at $88.73 per share on Dec. 30, that puts it on a forward multiple of just 16.7x. Barchart says its survey of 12 analysts projects $5.08 EPS for 2023. This puts it on a forward 17.5x multiple and an EPS increase of 8.54%.

Trading Below Historical Averages

Both of these forward price-to-earnings (P/E) estimates are well below Google's historical P/E average. For example, Morningstar says that the 5-year average for GOOG stock has been 25.73x. That means that using the most conservative estimate today (Barchart), GOOG stock is still 47% too cheap (i.e., 25.73x/17.5x-1=1.47-1=47.0%).

Moreover, Seeking Alpha says that the average historical multiple has been 26.73x, which is even higher than Morningstar. That implies a 60% upside (i.e., 26.73x/16.7x-1=1.60-1=60%).

As a result, we can afford to be conservative in setting a price target. For example, let's say that GOOG stock rises by only 50% of its historical average. That means it could trade between 50% of 47% to 60% higher. That works out to an upside of between 23.5% to 30%, or 26.75% on average. That puts the target price at $112.47 (i.e., 1.2675 x $88.75).

We can use this to figure out how to play this with options.

Making Money with GOOG Calls and Puts

One way to play this is to buy in-the-money calls for a long period in the future. For example, the $85.00 strike price calls for expiration on March 17, 2023, trade for just $8.48 per call option. That means that if the stock stays where it is today by March 17, at $88.73, there will still be at least $3.73 per share in intrinsic value (i.e., $88.73-$85.00). That represents 43.9% of the $8.48 call option price, providing a good deal of security and plenty of time for GOOG stock to rise.

The reason why you might consider doing this is that if GOOG stock rises to $112.50 by March 17, the target price from above, these March 17 calls will be worth $27.50 per option. That is 3.25x the price paid for the calls at $8.48 and an ROI of 225%.

One way to pay for this extra $4.75 in extrinsic value or extra premium (i.e., $8.48 call price - $3.73 intrinsic value) is to short near-term out-of-the-money puts. 

For example, the Jan. 27 puts at $85.00 strike price trade for $1.80. By shorting those puts for three months straight, you can pick up potentially $5.40 (i.e., $1.80 x 3), assuming the put price stays the same. That more than covers the potential $4.75 extrinsic value loss assuming GOOG stock stays the same by March 17. Keep in mind that the investor will have to put up $8500 in cash or margin with the brokerage firm to be able to “sell to open” GOOG stock.

This is a simple way that investors can play the upside in GOOG stock, as well as create income by doing so.

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