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Despite its recent run-up, analysts still believe that Salesforce Inc (CRM) stock is deeply undervalued. This is likely due to its strong free cash flow (FCF) and FCF margins. Shorting out-of-the-money puts work well here.
CRM stock closed at $253.97 on Friday, July 12. This was up significantly from its recent low of $218.01 on May 18. I discussed this in my June 18 Barchart article, “Salesforce Is Well Off Its Highs and Still Looks Cheap - Shorting OTM Puts Is a Great Way to Play This.”
Free Cash Flow Targets
In that article, I showed why Salesforce could generate substantial free cash flow (FCF). I projected that it could be worth at least $274.15 per share.
Now I believe that CRM stock could be worth as much as $289 per share over the next 12 months. This is based on using a 32% FCF margin estimate, as I explained in my May 31 Barchart article, “Salesforce Overreaction - CRM Stock Looks Deeply Undervalued Based on Its Massive FCF.”
Based on analysts' estimates of $41.39 billion in sales next year, and using a 32% FCF margin, Salesforce could end up making $13.24 billion in FCF (i.e., $41.39b x 0.32). That is up 9.4% from a projection of about $12.1 billion in FCF this year using the company's operating cash flow guidance.
As a result, using a 21x FCF multiple - the same as using a 4.75% FCF yield - the stock's market cap could reach $278 billion. That is 13% higher than today's market cap of $246 billion.
In other words, CRM stock is worth 13% more than its price today of $253.97, or $289 per share (i.e., 1.13 x $253.97 = $286.99).
Analysts See Higher Price Targets
I pointed out in my last article that analysts agree that CRM stock looks cheap here. They still do.
For example, 41 analysts surveyed by Yahoo! Finance have an average price target of $296.55 per share. And Barchart's survey shows a mean target of $293.27.
Moreover, AnaChart, a new sell-side analyst tracking service, shows that 38 analysts have an average price target of $296.08.
This serves to underline that most surveys of analyst price targets all have substantially higher price targets. The average of these surveys is $295.30, or 16.3% higher than today's price of $253.97.
In addition, Anachart shows that many successful analysts have much higher price targets. Look at the table below.
It shows that 3 analysts have price targets of $300 or higher. They all have substantial track records. Their “Price Targets Met Ratio” stats are all well over 50%.
For example, David Hynes of Canaccord has hit his price targets on CRM stock over 72.7% of the time. That gives a good deal of credence to his present $300 price target for CRM stock. There is a very high probability he will meet his price target this time as well. The same is true for Kirk Materne of Evercore who has a 71.4% Price Targets Met Ratio. He also has a $300 price target for CRM.
One way to play this is to sell short out-of-the-money (OTM) put options.
Shorting OTM Puts in CRM Stock
I have discussed this strategy in my last 2 articles on CRM in Barchart. For example, my June 18 Barchart article suggested shorting the $225 strike price put for the July 5 expiration period. This put expired worthless and the investor made a 0.88% yield (i.e., $1.99 premium/$225 strike price) for a 2.34% out-of-the-money (OTM) put strike price.
This serves to highlight the fact that this strategy works best for existing shareholders in CRM stock. That is based on the fact that shorting OTM put in essentially just an income play. To gain the upside in the stock you may want to short OTM calls (i.e., covered calls) or else also own shares in CRM stock while shorting OTM puts.
Today it's possible to still make extra income shorting puts at strike prices that are below today's price. For example, look at the August 2 expiration period, which is 3 weeks away.
It shows that the $245 strike price puts, which are 3.53% below today's price, have a bid side premium of $2.25 per put contract. That provides an immediate yield of almost 1% (i.e., $2.25/$245.00 = 0.91835%).
In other words, an investor who secures $24,500 in cash or margin with their brokerage firm can enter an order to “Sell to Open” 1 put contract at this strike price. The account will then receive $225. That equals 0.918% of the $24,500 invested.
Now, as long as CRM stock stays above $245 for the next three weeks, the investor will not have an obligation to have the $24,500 to buy 100 shares at $245.00.
Moreover, if this trade can be repeated over the next quarter, the investor has an expected return (ER) of almost $1,000 (i.e., $245 x 4 = $980). That is an ER yield of 4.0% on the $24,500 invested over that period.
The downside risk is that the stock falls well below $245. But even in that case, the investor has a breakeven price of $245-2.25, or $242.75. That is still 4.42% below today's price, providing good risk protection. Moreover, over time, after repeating this strategy, as I have discussed in my last 2 articles, the investor builds up extra income to lower the breakeven price.
The bottom line here is that analysts see CRM stock as undervalued. One way to play this, especially for existing investors, is to short OTM puts in nearby expiry periods.
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.
