Hi friends,

Alphabet’s stock has printed four consecutive green weekly candles this month, returning a handsome 6.6% in June.

From the November 2023 low of $85, GOOGL has more than doubled. Not bad for a mega-cap stock that’s been heavily criticised for its inferior Generative AI product to ChatGPT, Gemini (formerly Bard).

However, I believe the fates of the Gen-AI players are intertwined.

When building my startup, we built an iOS app with Google’s Firebase in the backend and ChatGPT as the AI model. The combination is simple, cost-effective and fast.

Apple uses Google (and receives $18 billion a year for it) as the default search engine, which will incorporate Google’s AI search features. Apple is launching its own “Apple Intelligence” this year outside of China and EU. Apple will use ChatGPT as backup for AI queries that the device cannot solve.

Therefore, while we have a competition between the Gen AI players, they are much more intricately linked in businesses than we are let to believe by the media.

Anyway, on to the charts and fundamentals analysis. I refer to GOOGL as the ticker for Alphabet. The difference between GOOGL and GOOG is that GOOGL has voting rights.

DISCLAIMER: None of this is financial advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. Please be careful and do your own research.

1. GOOGL Chart Completing 5 Waves Up

Click here for the full-size chart.

From the November 2023 low, we are coming close to the final wave v of 5 target at $187-192. This implies room for another 2-4%.

The overall chart is pretty extended by the standard measure. For example, wave 3 ended at the 2.382 extension of wave 1. The current wave 5 moved nearly straight up from the wave 4 low of $130 in early March. The momentum has been breakneck.

However, all good things do come to an end at some point. I am now waiting for the final bit of action in wave v of 5 to complete.

Seeing 5 waves down from the $187-$192 region would confirm my suspicion of a near-term top. This is because motive waves (the waves in the direction of the trend) happen in 5 waves, while the corrective waves occur in 3 waves. 5 waves down would show an initial sign of trend reversal.

2. Fundamentals do look reasonable

You may recall from my AMD analysis from two days ago, that I’m seeing a short-term long-side trade set up for AMD, but I am bearish in the medium term on the charts and fundamentals.

This is almost the opposite case.

While I see GOOGL completing its 5 waves up in the short-term and now due a correction, I think the fundamentals are actually reasonable.

Therefore, the next big price correction should present a buy-the-dip opportunity.

GOOGL Revenue reaccelerating

GOOGL went through some miserable growth period in 2023, after the stock fell from $150 to $83. This was because the market was forward looking.

GOOGL has now regained its footing, with growth back in the double digits. Q2 earnings should see GOOGL’s TTM Revenue rise to $328 billion, or 13% YoY.

GOOGL has also expanded its GAAP operating margin in the recent quarters, from 24% in Q4 2022 to 33% in Q1 2024.

However, because of its recent increase in CapEx in the AI race, the Free Cash Flow margin has contracted. I expect CapEx to continue to be heavy in the next two years (14% of revenue), before gradually moving back into a single digit.

Finally, GOOGL’s earnings multiples (EV/ EBITDA and P/E) have moved closely with the earnings growth, as seen in the bottom two charts.

Valuation versus Magnificent 7 peers also looks fair

Compared with its mega-cap peers, GOOGL’s forward P/E trades at 24x with an expected 2-year forward growth of 21% CAGR. This puts GOOGL’s PEG just above 1.

This is cheaper than MSFT, AAPL, and TSLA, but more expensive than NVDA, AMZN, and META. Right in the middle of the pack.

DCF Model supportive of valuation if GOOGL keeps up growth

Finally, if GOOGL and maintain a 10-13% growth in the next decade, the DCF model actually supports the current valuation of $185 per share. It also assumes CapEX comes down from 14% to 10%, a long-term operating income margin (excluding stock-based compensation) of 42%, and FCF margin (excluding SBC) of 31%.

This is doable.

However, the danger is if GOOGL slips back into the low single-digit growth like in 2023 (4-5%) and continues to spend heavily on CapEX. In that case, the fair value from the DCF model is around $140.

Tools I find helpful:

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Fastgraphs: I find Fastgraphs very useful in gauging whether a stock is underpriced or overpriced versus the fundamentals. Sign up here to get 25% off using the coupon “AFFILIATE25” at the check out.

A quick “Thank You”

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— Yimin

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