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Shopify Inc. (SHOP) stock looks like a bargain as the company is generating high free cash flow margins. Moreover, analysts are predicting higher sales over the next 12 months (NTM). That could push the value of SHOP stock up by 21.9% to $136.66.
In addition, shorting one-month out SHOP put options at 10% lower strike prices can give a 3.2% monthly yield. More on that below, but first let's see why SHOP stock looks cheap.
SHOP closed at $112.11 on Friday, well off its $129.31 high on Feb. 18, but up from the $77.09 low on April 8. But, using a free cash flow (FCF) margin and FCF yield metric model, it could have much more to go.
Shopify's FCF Margins - Catalyst
Shopify competes more and more with Amazon.com (AMZN), and it seems to be picking up market share. For example, Shopify had a strong Q1 (revenue +26.8% Y/Y) and management guided for a mid-20% increase in Q2.
Moreover, its free cash flow (FCF) margin in Q1 was very strong at 15% of sales. I have discussed this in prior Barchart articles, but suffice it to say that this is the single most important factor that will push SHOP stock higher.
Management knows this, and they spend a lot of time discussing FCF margins (just like their competitor Amazon - see my July 8 Barchart article on AMZN).
For example, last year it made $611 million in FCF, representing 22% of sales. The $363 million in FCF so far this year is already 60% of that figure.
That implies, if Shopify can keep this up, assuming its sales continue to skyrocket, its FCF could rise dramatically. Let's project it out.
Management told investors in Q1 that it expects Q2 FCF margins “to be in the mid-teens, similar to the first quarter of 2025.” Last year, it generated a 16% FCF margin in Q2.
So, if that occurs again, using analysts' Q2 sales forecast of $2.55 billion, it could make $408 million. Combined with the $363 million from Q1, its first-half FCF total of $771 million will already be higher than the $611 million generated last year.
As a result of higher sales projections, we can project significant gains in FCF even if its FCF margins stay flat. For example, analysts now project sales of $10.88 billion this year (+22.5% over last year's $8.88 billion in sales). And for 2026, they foresee +20.5% higher sales over 2025 at $13.11 billion.
So, using a next 12 months (NTM) sales forecast of $12 billion and an 18.5% FCF margin. That is up from the 18% FCF margin in 2024 and equal to its trailing 12-month (TTM) 18.42% FCF margin in Q1, as reported by Stock Analysis).
Therefore, it seems reasonable that FCF could rise to $2.4 billion. Here's how that works out:
18.5% FCF margin x $12 billion NTM revenue = $2.22 billion NTM FCF
That is still 263% higher than the $611 million generated in 2024 and +22.6% higher than its TTM FCF of $1.728 billion (from Stock Analysis). This could push SHOP stock higher.
FCF-Based Price Target
Using a FCF yield metric, we can forecast how the market will value SHOP over the next 12 months (NTM). For example, let's assume that 100% of its FCF is paid out in dividends (theoretically). What would the dividend yield (i.e., the FCF yield) be?
One clue is to look at its present FCF yield. For example, let's use the TTM $1.728 billion FCF and compare it to Shopify's market cap today is $145.736 billion according to Yahoo! Finance:
$1.728b TTM FCF / $145.736b mkt cap = 0.0119 = 1.20% FCF yield
So, let's apply that to our NTM forecast of $2.22 billion (and, to be conservative, raise the FCF yield to 1.25%):
$2.22 billion FCF / 0.0125 = $177.6 billion NTM mkt cap
That is +21.9% higher than its present $145.736 billion mkt cap, and implies that SHOP stock could be worth almost $137 per share:
$112.11 x 1.219 = $136.66 per share
In other words, if analysts' projections for over 21% higher sales growth over the next 12 months hold up and if Shopify makes a similar 18.5% FCF margin, the stock could easily rise by 22%.
Analysts tend to agree. For example, AnaChart.com, which tracks 34 sell-side analysts' price targets, including recent upgrades, shows an average price target of $122.79. That is 9.5% higher than today's price.
Nevertheless, there is no guarantee that SHOP stock will rise. It could stay flat or deteriorate, especially if revenue expectations and FCF margins falter.
Fortunately, one profitable way to play it is to sell short out-of-the-money (OTM) put options. That way, an investor can set a potential lower buy-in target price and get paid handsomely while waiting.
Shorting OTM Puts
For example, look at the Aug. 15 expiration, about one month from today (32 days to expiry or DTE). The $100.00 put option strike price, which is 10.8% below Friday's close, has an attractive midpoint premium of $3.28 per put contract.
That provides an investor an immediate 3.28% yield (i.e., $3.28/$100.00). This is because the investor is required to secure $10,000 to do this trade (i.e., $100 x 100 shares per contract). After entering an order to “Sell to Open” 1 put at $100.00, the account immediately receives $328.00.
The point is that this strike price is very defensive since it's over 10% below the trading price. In addition, the breakeven is lower at $96.72 ($100 - $3.28 received), or -13.7% below the stock's closing price on July 11.
That provides significant downside protection to the investor, should SHOP fall to $100.00 anytime in the next month. For example, the upside at our $136.66 target price is over 41%:
$136.66 / $96.72 = 1.413 -1 = +41.3% upside
Expected Return
The expected return (ER) over the next 3 months is high. For example, let's assume that 2 out of 3 times repeating this play, the puts expire worthless, but SHOP closes at $95.00 (i.e., an unrealized loss of $5.00). Here is the total expected return:
$3.28 x 3 = $9.84 - $5.00 = $4.84 net return, or 4.84% on the $100 cost over 3 months (i.e., 1.6133%/mo or 19.35% annualized)
That +19% ER is very high, even if SHOP stock falls and the investor's secured cash is assigned to buy 100 shares with an unrealized capital loss.
Moreover, for investors willing to take on more risk, the $105 strike price put has an even higher one-month yield:
$4.85 / $105.00 = 0.04619 = 4.62% one-month yield
This would produce a $4.55 net gain over 3 months (with a $10 unrealized loss in the same scenario), or an annualized ER of +18.20%.
The bottom line here is that SHOP stock looks deeply undervalued. One way to play it is to sell short 1-month away expiry puts for a 3.28% one-month yield with an expected 19%+ annualized return.
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.
