Google: 2 Ways To Generate Yield From This Growth Stock
Contributor since 2021 / 7237 Followers
Summary:
- Option strategies are excellent ways to generate cash flow.
- Alphabet has been the target of analyst downgrades as it was caught off guard by recent development.
- However, the product push, cash flow generation, and buyback program benefit shareholders.
- What’s a long-term investor to do? Use these option strategies to generate cash flow.
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What’s the latest on Google stock?
Playing catchup in AI
Have you ever seen a football play where the offense snaps the ball while the defense is still milling about, not set? This is a terrific analogy for Alphabet’s (NASDAQ:GOOG) (NASDAQ:GOOGL) position when ChatGPT became the rage. Luckily, being caught flatfooted on one play does not mean the game is lost.
Many commentators and investors soured on Google after Microsoft invested billions in ChatGPT to bring its technology to Bing. But the demise of Google Search is greatly exaggerated. According to the latest data on Statista, Google Search held 85.5% of the desktop search market compared to 8.2% for Bing as of March 2023. Google’s share is slightly higher than it was upon ChatGPT’s release.
Also, news out today says ChatGPT downloads on iPhones were down 38% in June.
Alphabet is urgently pushing its artificial intelligence (AI) and generative chatbot technology to market with Bard and PaLM2, its next-gen large language model. It also combined its two AI research groups, Brain and DeepMind, into one dubbed Google DeepMind. It has some of the highest-regarded minds in the industry in control.
Controlling expenses and cloud profits
CEO Sundar Pichai promised to make Alphabet more efficient last year to maximize profits and take advantage of a leaner, faster-moving enterprise. The workforce grew 22% from 157,000 to 190,000 in 2022, and Alphabet found that bigger is not always better.
Sometimes there are areas to make progress where you have three people making decisions, understanding that and bringing it down to two or one improves efficiency by 20% – Sundar Pichai speaking at a conference in 2022.
Airbnb (ABNB) is an excellent example. Its workforce was 5% smaller at the end of 2022 than in 2019, but revenues skyrocketed 75%, and the company has achieved record profits and cash flow.
On headcount, something really interesting happened…in 2020…we became a much smaller and more focused company. And the obvious result of that is that we got more efficient and more profitable. But there was a less obvious result. What ended up happening is we have fewer people in meetings, and people can move a lot faster. And we concentrate all of our very best people and put them on only a few problems. And I think that’s been an explanation for why the company has grown really quickly. – Airbnb CEO Brian Chesky.
Alphabet took $2.6 billion in restructuring charges in Q1 related to severances and office space downsizing, so the plan is underway.
Google Cloud also turned operating profitable in Q1 for the first time due to a change in estimates which reduced depreciation expenses. Some call this an accounting gimmick (and they have a point), but the critical takeaway is cash flow. If reducing a non-cash expense makes the segment profitable, then the Google Cloud segment is cash-flow positive and likely has been for some time – and bringing cash into the coffers is what it’s all about.
Alphabet’s plan will take time, and many analysts downgraded the stock (some downgraded while simultaneously raising price targets…huh?), so there is likely a cap on the price in the short term. And this opens up money-making opportunities for investors.
Option strategies are excellent and effective ways to generate income.
Who says stock splits don’t matter?
Write any analysis about a company splitting its stock, and “stock splits don’t matter” is a common response. While the splits don’t change the company’s value, they open up opportunities for investors to generate cash using options.
Options are sold in lots of 100 shares, so when Alphabet traded for $2,000 a share, one would need a $200,000 position to sell a call option. Now, we only need a $12,000 position – much more doable.
Without further ado, here are two ways to generate yield from a growth stock using options.
#1: Sell covered call options
For investors having at least 100 shares, selling out-of-the-money (OTM) covered calls has several advantages, such as:
- Generating cash;
- Mitigating short-term risk if the stock falls; and
- The ability to reinvest the cash into other money-making vehicles (like other stocks or interest-generating savings).
When we sell an OTM call option, it gives the buyer the right to purchase the stock at the strike price on or before the expiration date, and we pocket the premium. If the stock does not rise above the strike price, we keep the premium free and clear. Congratulations! We have just generated yield from a growth stock.
If the stock goes over the strike, we can buy back the call at a higher price or let the shares go for the strike price. The best play here is to repurchase the call and then sell another one for a later date and at a higher strike. This way, we recoup the premium and also keep the shares.
Here is an example: On May 22, a $145 October 20, 2023 Call netted $3.25 per share or $325. The same option can be repurchased at the time of this writing for just $0.98, netting the seller a $226 profit for each option. This amounts to ~2% yield in under two months. Doing this several times during the year creates a juicy yield.
We can pocket this now or hold out longer for a larger potential profit. I have an 80% rule: I repurchase it and lock in the profit once a covered call has reached an 80% gain. This opens up the ability to sell another call at a higher price when the stock has a short-term rally and mitigates the risk of something crazy happening before the expiration date. In the case above, I create a limit order to repurchase the option for $0.65.
The timing is right for this strategy since analyst downgrades and negative sentiment will likely keep the stock from rising precipitously in the short term.
#2: Selling cash-secured put options
This strategy takes advantage of Alphabet’s relatively strong performance (despite the negative sentiment) and prolific stock buyback program. Alphabet is still extremely profitable and generates oodles of cash from operations, $90 billion over the past twelve months.
In addition, the company increased the buyback program by $70 billion in April and has repurchased $61 billion over the past twelve months.
Both of these items support the stock price and make selling put options an attractive way to generate yield.
A put option gives the buyer the right to sell a stock for the strike price on or before the expiration date. For instance, if you sell a put option for $100 and the price stays above this, you keep the premium free and clear. If the stock price drops to $90, you still keep the premium but must purchase the shares for $100. Typically, we would repurchase the option at a loss rather than allowing the stock to be assigned.
A $105 November 17, 2023, put sells for $2.40 now, netting the seller $240 per option. The stock would have to fall 15% to $102.60 for the trade to lose money. This seems unlikely. Plus, at $102.60, many of us would add to our position anyway, making this option plan an excellent bet.
Selling puts is riskier than selling covered calls. If the stock were to crash due to a catastrophic market event or an accounting scandal, the seller could lose a bundle. This scenario is unlikely but not impossible.
The bottom line
Rumors of Alphabet’s decline are greatly exaggerated. The company is a cash flow machine, has a stranglehold on Search not likely to be lost anytime soon, and Google Cloud is posting impressive growth. Management’s commitment to cost controls and the aggressive buyback program will benefit long-term investors. Meanwhile, income-producing strategies, like the two above, are terrific ways to generate yield.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of GOOG, ABNB either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Investors' goals, financial situations, timelines, and risk tolerances vary widely. The stocks mentioned may not be suitable for all. As such, the article is not meant to suggest action on the part of the reader. Each investor should consider their unique situation and perform their own due diligence.
The author is SHORT OCT 20, 2023 $145 CALL(s).
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