PayPal Holdings (PYPL) stock seems to be stuck in a trading range for the past 6 months. Moreover, PYPL stock is cheap at just 11 times next year's forecast earnings. That makes it ideal as an income play by shorting out-of-the-money put options.
In morning trading on Friday, Dec. 29, PYPL was trading at $61.78 per share. This is close to where it was on June 29 at $65.86. That puts it in a stable trading range. This is exactly what short sellers of out-of-the-money (OTM) call and put options like to see.
Moreover, 45 analysts surveyed by Seeking Alpha forecast that earnings per share (EPS) will be $4.98. That puts PYPL stock on an inexpensive multiple of just 12.4x.
For 2024, they forecast an EPS of $5.60. That lowers its forward P/E multiple to just 11 times. That is very cheap for a tech stock.
Where This Leaves Investors in PYPL Stock
PayPal stock is likely worth considerably more than today's price. One reason is that the company is producing good amounts of free cash flow (FCF).
For example, in its latest quarter ending Sept. 30, the company generated $1.1 billion in FCF. That represents 14.9% of its $7.4 billion in net revenue for the quarter.
Based on this, we can forecast its future FCF. For example, analysts now predict revenue in 2024 will rise to $32.17 billion (up 8.6% from $29.61 billion forecast for 2023).
That means that by applying a 15% FCF margin to this revenue forecast, free cash flow could almost reach $5 billion (i.e., $32.17b x 0.15 = $4.83b). In other words, expect to see the company generate a lot of FCF, which it could use to pay out a dividend or buy back stock.
So, for example, using a 4% FCF yield metric (i.e., assuming it pays out FCF as a dividend and the market gives the stock a 4% yield), the market cap could become $120.8 billion. That is seen by dividing $4.83 billion by 4.0%.
Compared to today's market cap of $66.5 billion, this implies that the stock could rise by 81.4%. That puts the stock price target at $112 per share, up 81.3% from today's price of $61.78.
Just to be conservative, using a 5% FCF yield puts the market cap at around $100 billion (i.e., $4.83b/0.05=$96.6b). That is 47.5% higher than today and puts the price target at $91.13 per share.
In other words, PYPL stock looks very undervalued here. That is also attractive to short sellers of near-term expiry OTM put options.
Shorting OTM Puts for Income
For example, look at the Jan. 19, 2024, expiration period. It shows that the $58 strike price, which is over 7% below today's price, trades for 58 cents. That represents an immediate 1.0% yield to the short seller (i.e., $0.58/$58.00).
Moreover, the $59.00 strike price put, which is 5.55% OTM, trades for 81 cents per contract. That represents an immediate put yield of 1.37% (i.e., $0.81/$59.00).
This is ideal for the short seller of these puts as they have no risk that their existing shares if they are a shareholder in PYPL stock, can be sold. The worst that can happen is that the short seller of these puts will have to buy more shares either at $58.00 or $59.00. That depends on how many put contracts they sell short.
The bottom line is that, given how undervalued PYPL stock is right now, the short seller of puts can create extra income while they wait for the stock to rise.
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.
