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Nvidia Inc. (NVDA) stock is cheap based on free cash flow (FCF) price targets. Investors can short out-of-the-money (OTM) NVDA put options to make a 1-month 2.4% yield. This is at 5% lower exercise prices, providing a cheaper potential buy-in point for investors.
NVDA closed at $143.85 on Friday, June 20. In my last Barchart article on May 30, I argued that NVDA stock was worth $191.34 per share. That is still one-third (+33.0%) higher than Friday's price.
This article will discuss one way to play NVDA by shorting out-of-the-money (OTM) puts. That way, an investor can set a potentially lower buy-in point and get paid for this.
But first, let's look at Nvidia's free cash flow and the related price target.
Nvidia's Strong Free Cash Flow and Price Target
In my last Barchart article, I showed that Nvidia's Q1 FCF of $26.125 billion represented an astounding 59.3% of quarterly revenue. That means almost 60% of its sales revenue goes straight into its bank account with no cash outlays on it (even after record-high capex spending).
Moreover, I showed that over the last 12 months (LTM), its FCF margin was almost 50% (48.5%). That implies going forward its FCF could rise to a record high.
For example, based on analysts' next 12-month (NTM) projections of $225 billion, using a 50% FCF margin free cash flow could exceed $112 billion:
$225b x 50% FCF margin = $112.5b FCF
How to value NVDA? Let's think about what the market might be projecting. For example, let's assume the market believes Nvidia will make $100 billion in FCF, slightly less than 4 times its Q1 FCF.
So, given its market cap today of $3,508 billion, that represents a 2.85% yield:
$100b/$3,508 = 0.0285 = 2.850% FCF yield
So, using our NTM forecast of $112.5b, its market cap could rise to $3.75 trillion
$112.5b / 0.0285 = $3,947 billion NTM mkt cap
That represents an upside of 12.5% from today's market cap:
$3,947b / $3,508b mkt cap today = 1.125
Target Prices for NVDA
So, that makes its target price at least 12.5% more:
$143.85 x 1.125 = $161.83
However, if Nvidia makes better than 50% FCF margins over the next year, its target price could be much higher. For example, even a 10% higher FCF margin leads to a 24% upside:
0.55 x $225b = $123.75b FCF
$123.75b / 0.0285 FCF yield = $4,342 billion mkt cap;
$4,342b / $3,508b = 1.2377 = +23.8% upside
1.1238 x $143.85 p/sh = $178 per share
The bottom line is that Nvidia's strong FCF and FCF margins will lead to a significantly higher price, between $162 and $178 per share.
This coincides with what other analysts are projecting. For example, 66 analysts surveyed by Yahoo! Finance show an average price target of $172.60. Similarly, Barchart's mean survey shows $174.83 per share.
In addition, AnaChart.com, which tracks analysts who have written recently on NVDA stock, has an average price of $179.87 from 40 analysts.
My analysis above shows you why these analysts have these higher price targets.
But there is no guarantee NVDA will rise to these targets over the next year. So, one way to play this is to sell short out-of-the-money (OTM) puts in nearby expiry periods.
Shorting OTM Puts
In my May 30 Barchart article, I suggest selling short the $128 strike price put expiring July 3 for a 3.125% yield at a 3.72% out-of-the-money (i.e., below the trading price) strike. For example, the midpoint premium was $4.00, so $4.00/$128.00 equals 0.03125. That was for a one-month play (34 days to expiry or DTE).
Today, that strike price has a much lower premium of just 39 cents. So, an investor has already made $3.61 (i.e., $4.00-$0.39), or a net 2.82% yield (i.e., $3.61/$128 = 0.028).
It makes sense to roll this over and set a new one-month short-put play. That means buying back the short put at 39 cents and reinvesting at a slightly higher strike price one month out.
For example, look at the July 25 expiration period (i.e., 34 DTE). It shows that the $137 strike price put options expiring July 25, i.e., 4.7% below Friday's price, have a $3.40 midpoint premium.
That means a new short seller of these puts can make a 2.48% yield over the next month (i.e., $3.40/$137.00 = 0.0248). For less risk-averse investors, a 2.70% yield is possible at the $138 strike price(i.e., $3.72/$138.00 = 0.02696). This strike price is just 4% below Friday's close.
Moreover, even after rolling the prior trade over, the net yield with the $137 strike put play is still 2.20% (i.e., $3.40-0.39 = $3.01/$137.00 = 0.02197).
So, that means over two months, a short seller of these OTM puts will have made 2.82% plus 2.20%, or 5.02% total (2.51% on average for both months).
In addition, an investor's breakeven point, even if NVDA falls to $137.00 over the next month, is lower:
$137 - $3.40 = $133.60 p/ sh
That is -7.125% below Friday's closing price. In other words, this is a good way to set a lower buy-in point for new investors in NVDA stock.
For existing investors, it is a way to potentially lower their average cost, as well as produce extra income on their holdings. And don't forget, given the target price of $172.60, the breakeven point presents a potential upside of over 29%:
$172.60/$133.60-1 = 1.292 -1 = +29.2% upside
The bottom line is that investors can potentially make over a 2% yield over the next month shorting these out-of-the-money (OTM) puts.
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.
