Nvidia Is Still Deeply Undervalued - Short OTM Puts for Extra Income

Nvidia Corp (NVDA) stock has risen nicely since its earnings results on Nov. 21. Based on our model forecast, NVDA still has room to rise. This means existing shareholders can sell short OTM puts for extra income.

I discussed the company's potential upside in my Nov. 26 Barchart article, “Nvidia's Blowout Quarterly Results Imply NVDA Stock Could Be Worth Over $700 Per Share.” This was based on the company's very powerful free cash flow (FCF) and its high FCF margins.

Why NVDA Stock Could Still Move Higher

For example, Nvidia reported that its FCF was $7 billion on $18.1 billion in revenue during Q3. That represents a huge 38.9% FCF margin. 

It means that almost 40% of all revenue, after all cash outflows including capex spending and changes in working capital, goes straight into its checking account. In fact, its nine-month results showed a 40.5% FCF margin.

Based on that we can forecast its potential free cash flow next year and then use that to value NVDA stock.

For example, analysts surveyed by Seeking Alpha now project that 2024 revenue could rise by 54% to $90.66 billion (up from $58.77 billion this year). Therefore, if we apply a 40% FCF margin to that estimate we get $36.3 billion in projected free cash flow next year.

That is huge. For example, Seeking Alpha shows that its trailing 12-month (TTM) FCF as of Q3 was just $17.5 billion. That is the result of subtracting $1.3 billion in capex from its TTM cash flow from operations (CFFO) of $18.8 billion).

NVDA Price Targets

In other words, we can expect that Nvidia's FCF will more than double from $17.5 billion to $36.3 billion by the end of 2024. 

That implies that NVDA stock could easily double from here. That gives us a price target of $980 per share. But let's get a little more exact about this forecast.

For example, if the market assumes that Nvidia were to pay out all of its FCF as a dividend, it's likely the stock would end up with at least a 2.0% dividend yield. So, by dividing $36.3 billion by 2.0% we get a market cap target of $1,815 billion.

That represents a 49.3% gain over its present $1.216 billion market cap. In other words, the price target is over $734 per share (i.e., $492 per share price today x 1.493).

This means that if the company's free cash flow continues to surge along with revenue gains next year, the stock could jump almost 50% from here.

Analysts also see this. For example, Yahoo! Finance reports, using data from Refinitiv, that the average target price of 46 analysts is $641.23 per share. This represents a 30% upside from here or a gain of $149.23 per share over the next 6 to 12 months.

That is similar to the AnaChart.com survey, which shows that the average of 38 analysts who have written on the stock recently is $108.50 higher, or $589.61 per share. AnaChart also shows that the best-performing analyst covering the stock has been Richard Shannon of Craig Hallum. He has the highest performance score of all analysts surveyed by AnaChart.com.

Shorting OTM Put Options for Extra Income

Existing shareholders can get paid to wait until the stock rises. They can do this by shorting out-of-the-money (OTM) put options in near-term expiry periods.

For example, look at the Jan. 12, 2024, expiration option chain. That is 3 weeks away from today. 

It shows that the $460.00 strike price puts expiring on 1/12/24 trade for $4.70 on the bid side. That implies that the short seller of these puts can make an immediate 1.02% yield (i.e., $4.70/$460.00).

NVDA Puts - Expiring Jan. 12, 2024 - Barchart - As of Dec. 22, 2023

This strike price is also almost 6.50% below today's price, providing good downside protection. That means that it is 6.50% out-of-the-money and NVDA would have to fall by 6.50% before there would be any obligation by the short seller of these puts to buy 100 shares of NVDA at $460.00 for every put contract shorted.

Since there are 17 periods of 3 weeks in a year, if this trade is repeated every 3 weeks, the annualized expected return (ER) is 17.3% (i.e., 1.02% x 17). 

Investors can take less risk by shorting the $450 strike price and still receive a 0.679% yield (i.e., $3.05/$450.00). That works out to an annualized ER of 11.5%. This is a good return for most shareholders as they wait for the stock to rise to its much higher target price.

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.