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Amazon (AMZN) is gushing free cash flow again based on its latest quarterly results. Based on 2024 revenue estimates and a 4% FCF margin AMZN could rise 23% to $181.52 per share using a conservative FCF yield metric.
One way to play this is to sell short near-term expiration out-of-the-money (OTM) put options. That allows existing shareholders to generate income, as Amazon still does not pay a dividend to its shareholders. This is despite its positive free cash flow (FCF) generation. (It also does not buy back shares.)
Amazon's Free Cash Flow Could Rise
I discussed Amazon's potential upside value in my Nov. 7 Barchart article, “Amazon's Huge Increase in Positive Free Cash Flow Augurs Well for AMZN Stock.”
For example, last quarter it made $21.4 billion in FCF over the last 12 months (LTM). That represented 3.8% of its LTM revenue of $554 billion.
Using a 4% FCF margin (rounding up, assuming improvement) based on its next 12-month sales (NTM), we can estimate free cash flow going forward.
For example, analysts now forecast $635.7 billion in sales during 2024. That implies that Amazon's NTM FCF could be $25.4 billion (i.e. 0.04 x $635.7b).
AMZN Stock Could Be Worth Over $181 Per Share
This implies that AMZN stock could rise from here. For example, using a 1.5% FCF yield metric, AMZN would be worth $1,693 billion (i.e., $25.4b/0.15). This is the same FCF yield the stock presently has.
However, with the higher FCF levels, the market might raise its valuation metric. So, using a 1.25% FCF yield, the stock would be worth $2,032 billion (i.e., $25.4b/0.0125).
Since AMZN has a $1,510 billion market cap, this shows that the stock could rise between 12.1% (i.e., $1,693 billion market cap) and 34.6% (i.e., $2,032 billion). On average that is a potential 23% upside.
In other words, AMZN stock could be worth 23% more than its present price of $147.58 per share. That sets its price target at $181.52.
Sell Short Near-Term OTM Puts for Income
One way to play this is to sell short near-term expiration put options to generate income. That is because AMZN stock still does not pay a dividend. This way shareholders can get paid to wait for the stock to rise.
By shorting puts there is no danger that your shares will be sold, as with covered call plays.
For example, look at the Dec. 15 option expiration period. This shows that the $140 strike price, which is 4.57% below today's price (i.e., is out-of-the-money OTM), trades for 85 cents per contract.
That provides an immediate income of 0.607% for the short-seller (i.e., $0.85/$140). If this trade is repeated every 3 weeks for a year, the expected return is 10.3% (i.e., 0.607% x 17x). That is because there are 17 periods of 3 weeks in a year.
If an investor wants to take on a little more risk, they could short the $142 puts. That provides income of $1.25 per contract, or an immediate yield of 0.88% (i.e., $0.88/$142). But should AMZN fall to $142, the investor's cash security of $14,200 per contract shorted would be used to buy 100 shares at $142.
The bottom line is that AMZN shareholders have more ways to wait profitably for AMZN stock to rise, given its huge free cash flow.
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.
