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Nvidia (NVDA) stock could be worth at least 29% more at $1,016 per share and as much as 42% more at $1,120 based on its huge free cash flow (FCF) and FCF margins. Long investors can make extra income by shorting out-of-the-money (OTM) puts.
This is based on its blowout results reported on Feb. 21 for the fiscal Q4 ending Jan. 31. As a result, NVDA stock rose over 16% to $788.17 as of Friday, Feb. 23.
I suggested that NVDA would rise in my Jan. 8 Barchart article, “NVIDIA Is Blasting Off and Its Powerful FCF Could Push NVDA 50% Higher to Over $736," and my Nov. 26 article. This was based on an FCF margin and FCF yield analysis. My price target today is based on the same analysis.
FCF Margins Exceed 50%
Nvidia said its revenue rose 22% quarter over quarter and is up by 265% from the prior-year quarter. More importantly, its FCF rose to $11.2 billion, up from $7.04 billion in the prior quarter.
But even more amazing was the fact that its FCF margin rose to 50.8%. That means that over half of its $22.1 billion in quarterly revenue was converted into free cash flow. Free cash flow is what is left after covering all cash expenses, including capex spending and net changes in working capital.
So, we can use this to estimate FCF going forward. As I explained in a recent GuruFocus article, analysts predict at least $113 billion in revenue on average for the next two years.
This means that using a 50% FCF margin its free cash flow could rise to at least $56 billion (0.50 x $113b = $56.5b). Here is why that is important.
If the company were to pay out all of this in a dividend the stock would likely have at least a 2.0% dividend yield. That means that its market cap would be at least $2.8 trillion (i.e., $56b/0.02).
This is 42.1% over today's market cap of $1.97 trillion, according to Yahoo! Finance, based on its latest share count. In other words, NVDA stock could rise by 42.1% to $1,120 per share.
But just to be conservative, let's use a lower 45% FCF margin. That implies that Nvidia's FCF would be a run rate of $50.85 billion (i.e., 0.45 x $113b).
This means that its market cap would rise to $2.54 trillion, or 29% higher. That gives a minimum price target of $1,016 per share.
Shorting OTM Puts
NVDA stock has been volatile and this means its put option premiums have risen. Short sellers can take advantage of this to generate extra income.
For example, the March 15 expiration period, three weeks away, shows that the $750 put option contract trades for $16.30 per put contract. That represents an immediate 2.21% yield opportunity (i.e., $16.30/$750).
Moreover, more conservative investors can short the $740 strike price for $13.40. That presents a yield play of 1.81% (i.e., $13.40/$740).
Downside Risk Hedges
However, this is a considerable downside risk, given the volatility in NVDA stock. One way to hedge this is to short the $750 put for $16.30 and buy the $740 put for $13.40. That results in a net credit of $2.90. that still represents a yield of 0.38% on the $750 strike price.
But this still does not take care of the $10 spread risk (i.e., $750-$740). One way around that is to sell an equal number of covered calls at the $895 strike price for $7.00 in the midprice. In other words, as long as NVDA stays between $750 and $895 in the next three weeks, the investor can make $9.90 (i.e., $2.90 +$7.00). But even if falls below the $750 strike price by March 15 the net risk is $10-$0.90, or just $0.10 per option contract (i.e., $10 per put and call contract).
Meanwhile, the investor is holding NVDA long and can make the upside potential we described above.
Moreover, if the stock does not fall, the investor can sell the long put and thereby increase the overall return to a substantial profit, even with the downside risk. For example, if after a week and a half, NVDA stock has not fallen, the investor could sell the long put for potentially about $7.00. That means that the total income would be $2.90+7.00+7.00, or $16.90.
That represents a yield of 2.25% on the $750 short put risk. It lowers the breakeven to $733.10, or 7% below today's price. The upside risk is that NVDA rises to over $895 per share, forcing the investor to sell the covered call at that price. But this still represents a huge return.
For example, the capital gain will be 13.55% (i.e., $895/$788.17-1) and the income received (assuming the long put is sold at $7.00) is $16.90/$788.17, or 2.14%. That gives a total return of 15.69%.
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.
