Despite the Market Downturn, Alphabet Could Rebound Due to Its Strong Finances

InvestorPlace - Stock Market News, Stock Advice & Trading TipsGOOG stock will benefit from Alphabet's huge free cash flow and share buyback program, pushing EPS and the stock higher...

By Mark R. Hake

Investorplace.com - InvestorPlace

This story originally appeared on InvestorPlace

InvestorPlace - Stock Market News, Stock Advice & Trading Tips

It may be time to "buy the dip" with Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) stock, given its extremely strong financial earnings power. As I wrote in my last article on GOOG stock on Feb. 14, the company's stellar earnings report on Feb. 1, was a display of strength.

Alphabet Inc. (GOOG, GOOGL) and Google logos seen displayed on a smartphone
Source: IgorGolovniov / Shutterstock.com

As a result, GOOG stock could begin to recuperate from its downturn so far this year. As of midday March 3, Alphabet was down to $2,686.16, or 7.16% from the end of last year.

This is also not that uncommon for large tech stocks to make a rebound. Barron's just reported today that stocks rise an average of 9.6% after 18 weeks during past crises, according to Ned Davis Research. The online magazine also quotes a Citibank strategist that "growth stocks have been hit by rising real yields, but should benefit as they reverse."

Real yields refer to nominal rates less inflation. So as rates rise, this effectively lowers price-to-earnings (P/E) ratios. This is because rising earnings yields are mathematically the same as falling P/E multiples.

Where Things Stand With Alphabet

In the fourth quarter, Alphabet reported that its revenue rose 32% and its full-year sales were up 42%. Moreover, its net income rose 35.6% in Q4 and was up 88.8% to $76 billion for all of 2021. That was a stellar quarter and year.

Moreover, Alphabet's earnings per share (EPS) growth rate was higher than its net income growth. For example, EPS for 2021 was $112.20 vs. $58.61 in 2020. That means that its EPS was up 91.4% for the year vs. an 88.8% gain in net income gain in 2021.

How can that be? Isn't earnings per share just the same as net income divided by the number of shares? Yes, it is. But that is just if you look at the numerators.

You also have to look at the denominators (i.e., the shares outstanding). For example, in this case, Alphabet's EPS was higher since the number of shares decreased between both years.

This result is a direct result of the company's massive buybacks, which are financed by its free cash flow (FCF). In other words, Alphabet's FCF is so strong it allows the company to boost its EPS growth rate through buybacks.

By the way, this is a big commitment by Alphabet. It generated $18.55 billion in FCF during Q4 and for the whole year, it produced $67.01 billion. This can be seen on page 6 of the earnings report, with $91.65 billion of operating cash flow minus $24.64 billion of capital expenditures (capex). Now, out of this $67 billion in FCF in 2021 Alphabet spent $50.274 billion on share buybacks.

Why Its Buybacks Are So Important to GOOG Stock

This $50.3 billion in share buybacks represents 75% of its $67 billion in FCF and 19.5% of its $257.6 billion in revenue.

So, think about that. Alphabet made a huge commitment. In order to increase its EPS growth rate from 88.8% to 91.4%, a rise of 260 basis points, and a percentage gain of 2.93%, it spent three-quarters of its extra free cash flow and one-fifth of its sales.

Alphabet must really consider buybacks very important. It knows that the market will be able to give the stock a higher price-to-earnings (P/E) valuation as a result. It also knows that over time the reduction in shares adds up quite significantly.

For example, Alphabet's outstanding shares have fallen dramatically in the last five years. On Feb. 1, 2016 it had 688.32 million shares outstanding according to the cover page of its 2015 10-K. But by Jan. 25, 2022, its share count was down to 660.97 million shares. That is a drop of 3.97% over that whole period.

The reduction in the share count happened as the stock price rose from $828 per share to $2,665, or 222% over that period. That is an average of 26.3% per year on a compounded basis. The buybacks obviously helped put higher buyer pressure on the stock, plus they contributed to the higher rating of the stock.

Where This Leaves GOOG Stock Going Forward

Investors can expect that Alphabet will continue to produce huge free cash flow going forward and will continue to buy back large amounts of its stock.

As a result, it's highly possible that GOOG stock will benefit greatly from a lower share count, higher earnings per share, and a higher stock price.

On the date of publication, Mark Hake did not hold (either directly or indirectly) any positions 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.

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