Mastercard Inc. (MA) made a 45.9% free cash flow (FCF) margin in Q3. These huge FCF margins imply that MA stock could be worth over 30% more at $550 per share.
Moreover, existing shareholders can enhance the stock's paltry 0.63% dividend yield. They can do this by selling short out-of-the-money (OTM) put options for extra income.
This article will describe how to do that.
Free Cash Flow Implies 30% Upside for MA Stock
I discussed Mastercard's powerful free cash flow in my last Barchart article, on Dec. 25, “Mastercard Has 30% Upside From Here Based on Its Massive Free Cash Flow.” At the time, MA stock was at $424.10 per share. I recommended selling short the $410 strike puts that expire on Jan. 12 - this Friday. More on this below.
But first, let's review why MA stock is so undervalued. For example, as of Sept. 30, 2023, Mastercard generated $7.03 billion in FCF on $18.55 billion in sales year-to-date. That represents a 37.9% FCF margin on YTD sales.
Moreover, I showed in an earlier article, that the company's Q3 FCF margin was higher at 45.9%. This was because its adjusted FCF in Q3 was $2.999 billion on $6.533 billion in Q3 sales. In other words, the company's FCF margins are increasing.
As a result, we can project its FCF based on estimates for 2024 sales. Analysts surveyed by Seeking Alpha forecast an average revenue in 2024 of $28.08 billion. As a result, this year's free cash flow could potentially rise to $12.89 billion (i.e., 0.459 x $28.08 billion).
This could lead the stock to rise to a market cap of $515.6 billion. That is seen by using a 2.5% FCF yield metric, which is equivalent to a 40x multiple (i.e., 40x $12.89b). This is 30.6% higher than its existing $394.9 billion market cap.
In other words, MA stock could rise 30.6% from $421.09 to $550 per share.
Shorting OTM Puts for Extra Income
The problem is shareholders are only getting paid a small dividend yield (0.63%). This is not enough while they wait for MA stock to rise to this price.
However, any investor who followed our short put recommendation in our last article could have reaped an income of 0.446% in just 3 weeks. That was the result of selling short the $410 strike price put option expiring this Friday (Jan. 12) for $1.83 per contract (i.e., $1.83/$410.00).
Moreover, if that can be repeated every 3 weeks for a year, the investor's expected return (ER) is 7.59%, since there are 17 periods of 3 weeks in a year (i.e., 0.4463% x 17 = 7.59%).
For example, look at the Feb. 2, 2024, expiry period for MA put options. It shows that the $405 strike price puts, 3.89% below today's price, trade for $2.98 per contract. That works out to an immediate yield of 0.7358% for just 24 days until expiration.
This means that any investor who secures $40,500 in cash and/or margin with their brokerage firm can get approval to do this trade. The investor then enters an order to “Sell to Open” 1 put contract at $405.00 for expiration on Feb. 2. The account will then immediately receive $298.00. That represents 0.7358% of the $40.5K invested in this play.
So you can see if this trade is repeated every 3 weeks the investor could reap $5,066 in a year. That works out to an expected return (ER) of 12.5% of the $40.5K used in this trade. On top of this if the stock rises to our price target there is no obligation for the short put trader to buy more shares.
The bottom line is that MA stock looks very undervalued here. The company will likely report its Q4 earnings by Jan. 26, so this trade will expire shortly thereafter. If the company's free cash flow continues to stay strong, expect to make extra income with this short-put play.
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