/shutterstock_1606529806.jpg)
Nvidia Inc. (NVDA) stock could be worth as much as 33% more if its free cash flow (FCF) margins stay sky-high at an average of 47.5%. That could be good news for existing shareholders, especially those who sell short out-of-the-money (OTM) puts for income.
NVDA stock is off its recent highs at $870.28 today. But, based on its high FCF margins, which have averaged 47.5% recently, it could be worth up to one-third more. That makes its price target at $1,153 per share.
As a result, it makes sense for existing shareholders to hold on. Moreover, those who sell short OTM put options in nearby expiry periods can make extra income.
Previous OTM Short Play
I described this play in my last Barchart article on Nvidia on Feb. 25, “Nvidia Stock Could Be Worth 42% More at $1,120 - Put Short Sellers Find This Attractive.” At the time NVDA stock was $786.90 and I suggested it was worth $1,016 per share.
I recommended selling short the March 15 $750 strike price put option for $16.30 (and the $740 strike price as well). That gave the investor an immediate yield of 2.173% (i.e., $16.30/$750) with just 3 weeks until expiration. That put ended up worthless, so the investor kept the income and had no obligation to buy shares at $750.
It seems worthwhile to roll this trade over again. But first, let's review the price target thesis based on Nvidia's free cash flow.
Free Cash Flow and Price Target
One simple way to value Nvidia is to assume its FCF margins will persist and the market will reward the stock's valuation appropriately. Using FCF yield as a valuation metric we can set a price target.
For example, last quarter the company made $11.217 billion in FCF on quarterly revenue of $22.103 billion. That works out to a sky-high FCF margin of 50.75%. Moreover, in the prior 12 months, its FCF margin was high at 44.2% (i.e., $26.947 billion FCF on $60.922 billion in revenue).
So, for forecasting purposes, we can assume that the average FCF margin will be 47.5%. Let's apply that to forecasts of its revenue. For example, for the year ending Jan. 2025, analysts forecast sales of $110.91 billion, according to Seeking Alpha's survey of 47 analysts. Moreover, for the following year, they project $132.24 billion. So, sometime in the next 12 months (NTM), the run rate revenue forecast will be $121.6 billion.
Therefore, applying the 47.5% FCF margin shows that FCF could be on an NTM run rate of $57.76 billion. That is 114% higher than the $26.95 billion it made last year. Moreover, if we assume that Nvidia were to pay out 100% of this FCF as a dividend, the stock would likely have at least a 2.0% dividend yield. In fact, many other tech stocks have much lower yields.
Therefore, the valuation for Nvidia could reach $2,888 billion sometime in the next 12 months (i.e., $57.76 billion/0.02). That is 32.5% higher than its existing $2.18 trillion market cap. In other words, NVDA can have a potential price target of $1,153 per share (i.e., $870.28 x 1.325).
One way to play this, especially for existing shareholders, is to sell short out-of-the-money (OTM) put options. It is also a way to buy into NVDA stock cheaply with a good income yield (if the stock falls).
Shorting OTM Puts for Income
For example, look at the April 12 expiration period, 24 days from now. The $840 strike price put options, which are 3.4% below today's price, trade for $27.85 per put contract.
That means that a short-seller of these puts can make an immediate yield of 3.315% (i.e., $27.85/$840.00).
This is because to gain this income the investor has to secure $84,000 (i.e., $840 x 100) in cash and/or margin with their brokerage per contract shorted. After entering an order to “Sell to Open” one put contract at $840, the account will immediately receive $2,785 (i.e., $27.85 x 100), or 3.315% of the amount invested.
Moreover, even if the stock falls to this level sometime in the next three weeks, it allows the investor to buy in at a cheaper price. They get to keep the 3.315% in income as well. That lowers the breakeven price to $840-$27.85, or $812.15 per share. That is 8.30% in downside protection compared to today's price.
The bottom line is that NVDA is worth considerably more if its FCF margins stay at these elevated levels. We can project a price target of $1,153 per share as its value sometime in the next 12 months, based on an average 47.5% FCF margin and a 2.0% FCF yield metric.
As a result, it makes sense to sell short OTM puts, especially for existing shareholders, to gain extra income or as a cheaper way to buy into the stock.
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.
