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Meta Platforms (META) reported impressive Q3 earnings on Oct. 25 with a huge $13.46 billion in free cash flow. That works out to 40% of its $34.1 billion in quarterly revenue. META stock could rise well over $400 if the company can keep its FCF margins this high.
The company's free cash flow (FCF), which represents all its cash expenses and expenditures, including capex spending and working capital changes, is money that goes straight to its bank balance. It spent a good deal of that FCF on shareholder-friendly share repurchases - $3.7 billion in Q3 alone.
As a result, its bank balance and marketable securities rose by $7.7 billion to over $61.1 billion now. The remainder of the FCF ($2.2) billion was spent on debt payments and taxes.
Free Cash Flow Could Power META Stock Higher
Based on this massive 40% FCF margin, it's possible to set a price target that is significantly higher than today's price (Friday, Oct. 27 close) of $296.73. Moreover, we could see it rise well over $400 per share.
This is the highest FCF the company has made in the last several years, as seen in the table below.
Here's how the target price estimation works. Let's assume that Meta Platforms can average 40% FCF margins over the next year. That means that 40% of the revenue will convert into free cash flow.
For example, analysts project revenue for 2023 will reach $133 billion this year, and rise 12.8% to $150 billion next year. So on average, for the next 12 months, sales could be $141.5 billion.
That implies that its FCF could be $56.6 billion over the next 12 months. To be conservative, let's just call it $55 billion.
Next, let's project that the market decides to give the company a 5% FCF yield valuation. That is the same as multiplying the FCF by 20x (i.e., 1/0.05 = 20x).
This means that META stock will eventually reach a market cap of $1.1 trillion (i.e., 20x $55 billion). Today, the market cap is $762.56 billion. This implies that the stock could rise by over 44%.
So, multiplying its price today of $296.73 x 1.44 gives us a target price of $427.29 per share.
Shorting OTM Puts for Income
Right now Meta does not pay a dividend. So, one way to make income from META while waiting for the stock to rise is to sell short out-of-the-money put options in near-term expiration periods. Combined with holding META stock, this provides investors with a good way to create pseudo dividends.
For example, look at the Nov. 17 expiration put option chain. This is 3 weeks from today. The put option premiums are quite high and can provide a good income for short sellers of these puts.
One example of this is the $275 strike price put option. The premium at the bid point is $3.45 per contract. That implies that the investor selling short these puts for expiration in 3 weeks makes an immediate income of 1.36% (i.e., $3.45/$275).
Moreover, if this short-put play can be repeated every three weeks, or 17 times in a year, the annualized expected return is over 23% (i.e., 1.363% x 17 = 23.2%). These high premiums may not last, but it shows that today's return is very attractive.
In effect, an investor who secures $27,500 (i.e., $275 x 100) with their brokerage firm, can then enter an order to “Sell to Open” 1 put contract at $275 for Nov. 17 expiration. Their account will immediately receive $345 (i.e., $3.45 x 100). That $345 represents a 1.363% yield on the $27,500 invested. If it can be repeated 4x over a quarter, the investor stands to make $1,452 per quarter, and if done 17x in a year, $6,171.
There is no guarantee that prices will remain this high. Moreover, the stock could fall to $275.00 and then the investor's cash would be used to purchase 100 shares of META stock. But at least the investor gets to keep the income. Over time this lowers the average buy-in price for the investor and provides 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.
