Google stock is rising after Morgan Stanley analysts said a mix of factors has created a bullish setup for 2017. Alphabet’s new Pixel phones are a key ingredient, but they also see a number of catalysts for Google Websites and note that the company’s relative price to earnings multiple is now at its lowest level in about 18 months.
Google stock has been underperforming
In a research note dated Nov. 27, Morgan Stanley analyst Brian Nowak noted that Google stock has underperformed the rest of its Internet peer group by 1,500 basis points year to date. The stock has also underperformed the S&P 500 by 800 basis points so far this year, and Nowak believes it is because investors are focusing on deleverage of traffic acquisition costs and Alphabet’s tumbling core operating margins.
However, he sees absolute dollars as being more important than percentage margins. He also notes that the core Google Websites business, which contributes about 80% of Alphabet’s revenue, is still growing faster than most expect. Additionally, forward estimates for earnings per share are up 3% so far this year, while the company’s relative PE multiple has compressed by 13% since the beginning of the year, reaching its lowest level since July 2015. At that time, forward growth estimates for earnings per share were a stunning 35% lower than where they are now.
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Nowak believes that all of these factors and Alphabet’s continuing innovation create an attractive entry point for Google stock.
Google Websites and Pixel phones offering up big opportunities
The analyst believes that Google Maps, expanded text ads and the addition of the fourth mobile ad unit will add a total of $2.7 billion in incremental revenue to Alphabet in 2017. He estimates that these additions will also add about 400 basis points to the year over year revenue growth just for Google Websites. He noted that investors are still concerned that Websites’ growth will decelerate into the teens, but he sees all of these factors resulting in a 22% growth rate for next year.
Then there are Alphabet’s new Pixel phones, and Nowak estimates that the company will sell 3 million units in the fourth quarter and 5.5 million units next year. He pegs revenue from the Pixel at about $4 billion and gross profit at $900 million for 2017. Those numbers may not seem like much, especially for a company as massive as Alphabet, but he believes the Pixel will become an important part of Alphabet.
Pixel to be important for Alphabet’s future
The reason is because the company is working to offer “a more integrated and consistent Android experience” and improving mobile search monetization among Android users. Nowak notes that iOS users still spend about three times more than Android users through shopping apps. In North America, this metric shoots up to five times more. As a result, advertisers see a higher return on investment and better mobile search monetization on iOS.
Nowak sees the Pixel as a tool for the company to start closing the gap among the more than 1.4 billion Android users in the future, adding that the phone could result in “materially faster” revenue growth on both a gross and net basis for Alphabet.
He continues to rate Google stock as Overweight with a $950 price target, although he raised his adjusted earnings per share estimate by 1%, putting him 4% ahead of the Street.
Chart technician bets big on Alphabet stock
Nowak isn’t the only one talking up Google stock this week. Chart technician Todd Gordon of TradingAnalysis.com explained to CNBC why he expects Alphabet shares to rise further. One pattern he identified is a three-wave correction on the daily Google stock chart, which he said started at the end of last month. The three-wave correction basically is two downward trends bracketing a short rally, which occurred toward the beginning of this month. He said that this pattern suggests Google stock will continue to rise, just as it has recently.
Gordon also identified an inverse head and shoulders pattern on the stock chart with a new support level at $785, which was previously the resistance level of the stock. In anticipation of a rally in Alphabet/ Google stock, the trader is buying the December 820 strike calls and selling the December 825 strike calls at $1.25 per share. This options play is a bet that the stock will close higher than $825 on Dec. 16, which would carry a profit of $375. So if he’s right, he will quadruple his money with this play.
Class A shares of Alphabet rose by as much as 1.3% to $796.02 during regular trading hours on Tuesday.