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Meta (META) is producing massive amounts of free cash flow (FCF). As a result, META stock could be at least 30% undervalued based on a valuation using its 40% FCF margins and a 5% FCF yield metric. A good income strategy to take advantage of this is to short near-term OTM put options.
I discussed this in my Oct. 29 Barchart article, “Meta's Massive Free Cash Flow Could Push the Stock Well Over $400.” I discussed why META stock could rise to over $400 based on its powerful free cash flow as well as an option play.
For example, I suggested shorting the Nov. 17 $275.00 strike price put option that sold for $3.45. That produced an immediate income of 1.25% (i.e., $3.45/$275) to the short seller of those puts. The stock closed at $335.04 on Nov. 17 so there was no exercise of the option.
I will discuss another put option play below. But first, let's recap why META stock is so undervalued.
Meta's FCF Could Push the Stock Higher
Last quarter the company generated $13.6 billion in free cash flow on $34.1 billion in revenue. That works out to a 40% FCF margin.
Using that margin we can estimate how much FCF it will generate next year. For example, analysts project it will make $133.3 billion in revenue this year and $150.6 billion in 2024.
So, applying a 40% margin, implies that Meta's FCF could range between $53.3 billion and $60.2 billion over the next year. That averages out to $56.8 billion in FCF - a truly massive amount.
The market will value META stock appropriately. For example, using a conservative 5% FCF yield metric, Meta could have a $1.135 trillion market cap (i.e., $56.77b/0.05). This is the same as a market value of $1,135 billion.
That represents a 30.5% rise over today's market cap of $870.1 billion. In other words, META stock could be worth 30.5% more than its price today of $338.91. That means its target price is $442.27.
So, it makes sense for META investors to hold the stock long-term.
However, Meta does not pay a dividend. One way to conservatively create income without any risk of having to sell your shares is to sell short out-of-the-money (OTM) put options. This works best in near-term expiration periods, as I described in my last article.
Shorting OTM Near-Term Puts for Income
For example, look at the expiration period ending Dec. 22, about 3 weeks away. It shows that the $325 strike price puts, which are over 4% out-of-the-money (OTM) (i.e., below today's price), trade for $3.55 on the bid side.
That represents an immediate income yield of 1.09% to the short seller of those puts (i.e., $3.55/$325.00). Moreover, if this trade can be repeated every month for a year, the expected return is over 13% annually.
Here is what this means on a practical level. First, the investor secures $32,500 in cash and/or margin with their brokerage firm. Then they enter an order to “Sell to Open” 1 put contract at the $325 strike price for expiration on Dec. 22.
The account will then immediately receive $355 (i.e., $3.55 x 100, since each contract represents 100 shares). So, that $355 represents over 1% of the $32,500 invested in the play.
As long as META stock stays above $325 over the next 25 days, the investor's $32,500 won't be automatically used to buy 100 shares at $325 per share. But, even if that happens, the investor still keeps the $325 already earned. That means that the breakeven price is $325-$3.55, or $321.45. So the investor has good downside protection, over 5% below today's price.
The bottom line is that META stock is worth at least 30% more. Existing shareholders can wait patiently for this to happen by shorting OTM puts for 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.
