Alphabet Inc. (GOOG GOOGL) will release its earnings after trading hours on Tuesday, Oct. 29. GOOG stock has been in a trading range ahead of the earnings release. The stock looks cheap here; if earnings come in strong, it could spike.

GOOG closed at $166.99 on Friday, Oct. 25. It's been trading between a low of $149.54 on Sept. 9 and $192.66 on July 10.

But the stock looks cheap here. I discussed in my recent Oct 15 Barchart article, “Alphabet Stock Looks Cheap - Analysts Raising Price Targets.” In addition, my Sept. 10 article, “Alphabet Stock Is Down, But Not Out - GOOGL Could Be Worth 29% More,” discussed the company's valuation. 

I argued that GOOG stock is worth at least $194.53 per share based on its strong free cash flow (FCF). What is the market expecting to see?

What To Expect in Q3

In Q2 the company generated a strong 16% FCF margin - i.e., $13.54 billion in FCF / $84.74 billion in quarterly revenue. Moreover, in the last 12 months (LTM) its FCF margin was 18.5%.

Therefore analysts will likely be looking for the company to generate at least the same 16% - 18.5% FCF margin in Q3.\

For example, analysts are currently forecasting revenue of $86.23 billion in Q3. That means that to achieve at least a 16% FCF margin, free cash flow should be at least $13.8 billion in Q3. 

Moreover, if FCF rises over $16 billion, that would exceed its historical 18.5% margin level. That could push the stock much higher.

Analysts' Price Targets For GOOG Stock

Analysts have significantly higher stock price targets for GOOG stock. For example, Yahoo! Finance reports that an average analyst price target of $202.69 for GOOG stock. Similarly, Barchart's survey shows a mean price of $202.33 per share.

This implies that GOOG stock has over 21.5% upside from Friday's price of $166.59.

In addition, AnaChart.com, a site that tracks how well analysts' price targets perform, shows an average of $184.10 from 10 analysts. However, several analysts have recently raised their price targets.

For example, AnaChart shows that two of three analysts on GOOG who've changed their price recommendations in the last 3 months have raised their target prices. This can be seen in the table below.

It shows that the UBS and Cowen analysts raised their price targets, ad the Oppenheimer analyst lowered his target. But note that these price targets are all still well over today's price. Also note that each one of these analysts has very good track records. Their “Price Targets Met Ratios” metrics show that they have been on target 93% to 96% of the time.

That implies that GOOG stock still looks deeply undervalued here.

The bottom line is that if Alphabet reports decent earnings and free cash flow it's possible that GOOG stock could rise to its higher price targets.

How To Play This

I suggested in my last article that it might make sense to short out-of-the-money (OTM) put options in nearby expiry periods.

For example, I recommended shorting the $155 strike price put option that expires on Nov. 8. At the time, this was 7.5% below the trading price and the premium of $1.74 represented a short-put yield of 1.122% (i.e., $1.74/$155.00).

That trade still looks attractive since the premium is still high at $1.70 on the bid side. However, this is less than 2 weeks away from expiration.

New investors might want to short the 3-week away Nov. 15 $155 put strike price which has a $2.00 bid side premium.

That means that the investor who does a cash-secured short put play here can make a slightly higher yield of $1.29% (i.e., $2.00 / $155.00). Moreover, it has a similar delta factor, which is quite low at just 21%. This indicates that the risk of assignment is not that high.

If GOOG stock falls to $155.00, the investor's cash will be assigned to purchase shares at $155.00. That would occur if the stock actually fell below $155.00 or close to that price. But given that the price target is still high at between $184 to over $202 per share for the next year, this may be a good investment.

Moreover, the investor can always sell covered calls or more OTM put plays to increase income. That could help the investor to make enough to reduce or eliminate any unrealized loss from being forced to buy shares at $155.00.

The bottom line is that GOOG stock looks cheap here. If earnings come in at a 16% FCF margin or higher it's possible that GOOG stock could rise out of its present trading range.

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On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.