Netflix Stock Could Be Worth 33% More Based on Its Powerful Free Cash Flow

Netflix (NFLX) is increasing as analysts realize its free cash flow (FCF)could rise to $9 billion annually. That means its market cap could rise to $270 billion, up from $203 billion today. That valuation is based on a 3.33% FCF yield. This implies that NFLX stock could be worth 33% more at $626 per share.

In morning trading on Monday, November 20, NFLX stock is $469.67. The stock is up 35.6% in the last month since Oct. 18 when Netflix released its Q3 earnings after the market close on Oct. 18 when NFLX closed at $346.19.

FCF Could Power Netflix Higher

I discussed its massive free cash flow (FCF) in my Oct. 20 Barchart article, “Netflix Stock Powers Ahead Based on Its Massive Free Cash Flow.” For example, Netflix generated almost $1.9 billion in FCF during Q3. It also made a 22.1% FCF margin - i.e., FCF divided by its Q3 sales of $8.69 billion.

A survey of 41 analysts by Seeking Alpha shows an average forecast of $33.6 billion in 2023 sales and $38.24 billion in 2024. That implies a huge 13.8% sales growth in 2024. 

As a result, its FCF margin is likely to rise as well to at least 24%, given how operating leverage works with higher sales.

That means that if we apply this 24% margin to the $38.24 billion sales forecast for 2024, free cash flow could exceed $9 billion (i.e. 0.24 x $38.24b = $9.18b).

This is what is pushing NFLX stock higher.

NFLX Stock Could Hit $626 Per Share

For example, let's assume that the market eventually gives Netflix a valuation at a 3.33% FCF yield. That is the same as multiplying FCF by 30x (since the inverse of 3.33% is 30, i.e., 1/0.033 = 30). 

This is a typical valuation for a large-cap stock with a large free cash flow generation capability. For example, Microsoft now has a trailing 2.1% FCF yield. It generated almost $60 billion in FCF in the last 12 months. Its market cap is $2.75 trillion. So, $60b/$2,750 b equals 2.1%.

As a result, this implies that Netflix's market cap could reach $270 billion (i.e., $9 billion x 30). This is 33% higher than its present $203 billion market cap.

In other words, NFLX stock, at $469.67, could eventually rise by one-third to over $626 per share.

Shorting Near-Term OTM Puts for Income

One way for existing shareholders to play this is to short near-term out-of-the-money (OTM) puts. Netflix does not pay a dividend, despite its huge FCF. 

Therefore, this short options play allows shareholders to generate income while they wait for NFLX stock to rise.

For example, in my last article, I recommended shorting the $380 puts expiring Nov. 10, three weeks away. The income worked out to a 1.36% immediate yield. The puts expired worthless and investors kept the income. They also had no obligation of being forced to buy the stock at $380 by Nov. 10.

Today, a similar short yield is available. For example, the Dec. 15 expiration period shows that the $450 puts trade for $4.35 on the bid side. That represents almost a 1% yield (i..e, $4.35/$450 = 0.97%) for just 25 days until expiration.

NFLX Puts expiring Dec. 15 - Barchart - As of Nov. 20, 2023

Moreover, since there are 14 periods of 25 days in a year, this represents a potential annualized expected return of 13.6% (i.e., 0.97% x 14). That is a very good income yield, assuming it can be repeated.

However, there is some downside risk. Keep in mind that the $450 strike price is less than 4.0% below today's price. That means that if NFLX falls by 3.93% to $450 the investor would have to purchase 100 shares at $450.

That might not be such a bad thing, if, as we have shown, the stock is worth $626 per share sometime next year. That means an existing shareholder could be happy to hold the extra shares. Meanwhile, the actual breakeven price is lower at $445.65 by $4.35 from the income received - i.e., $450-$4.35 = $445.65. That represents downside protection of over 5.1%.

The bottom line is that due to its huge FCF, Netflix stock is worth considerably more. Shareholders can take advantage of this buy selling short near-term OTM puts for extra income.

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.