Palantir Is Down, But Its FCF Could Make It Worth 21% More at $20 Per Share

Palantir Technologies (PLTR) stock is off its peak of $21.26 per share to $16.76 as of morning trading on Monday, Jan. 15, 2024. But the intelligence software company's powerful free cash flow could push PLTR stock up over 21% to that peak. One way investors can play this is to short OTM puts.

I discussed this in my last article on Dec. 4, 2023, “Palantir Still Has Room to Rise, and Could Be Worth Up to 20% More.” At the time the stock was $18.50 and we suggested shorting the $17.00 put options for expiration on Dec. 29. It closed at $17.17 so the investor would have had no obligation to buy more shares. 

It might make sense to short out-of-the-money (OTM) puts again. But first, let's review why PLTR stock could be worth up to 21% more.

Free Cash Flow Powerhouse

Palantir produced adjusted free cash flow (FCF) of $141 million in Q3. That represented a 25% margin on its quarterly revenue of $558 million, which was up 17% YoY. We can use that to project its ongoing free cash flow.

For example, analysts surveyed by Seeking Alpha forecast 2024 revenue of $2.66 billion. So, if we apply a 25% margin to this forecast we can project $665 million for 2024. 

That is useful because if we assume the market will use a 1.5% FCF metric, its market cap will rise to $44.33 billion. Here is how that works. 

If we assume that the company were to pay out all FCF as a dividend the market would give the stock a 1.5% dividend yield. So, $665 million divided by 1.5% gives us a market cap of $44.33 billion.

That is 21.6% higher than its market cap of $36.47 billion. In other words, PLTR stock is worth 21.6% more than its price on Friday, Jan 12 ($16.76), or $20.38 per share.

Shorting OTM Puts for Income

The problem is Palantir still does not pay a dividend out of its free cash flow. So, shareholders can create pseudo income while they wait for the stock to hit its target price.

One way to do this is to short out-of-the-money (OTM) puts in near-term expiry periods. That means selling puts at strike prices below the spot price. This is because the short sale process involves a potential purchase of the stock at the OTM strike price. 

This way shareholders can create income without having to worry that their shares will be called out or exercised. The only potential obligation will be to buy more stock at the OTM strike price.

For example, look at the Feb. 2, 2024, options expiration period, which is three weeks away, and likely close to when the company will release its Q4 results. It shows that the $15.50 strike price puts, which is 7.5% below today's price, trade for 24 cents.

That means that the short put investor can make an immediate 1.55% yield (i.e., $0.24/$15.50) selling puts at this strike price.

PLTR Puts expiring Feb 2, 2024 - Barchart - As of Jan 12, 2024

Here is how that works. An investor in PLTR stock can short these puts by first securing $1,550 in cash and/or margin with their brokerage firm. That allows the account to potentially buy 100 shares at $15.50 should the stock fall to that price and the put contract is exercised (since one put equals 100 shares).

Then the investor enters an order to “Sell to Open” 1 put contract at the $15.50 strike price for expiration on Feb. 2. That means that the investor's account will immediately receive $24 (i.e., $0.24 x 100 shares per contract). 

So, for example, if the investor sold short 10 contracts their account would receive $240.00, although they would have had to secure $15,500 with their brokerage firm. As a result, the $240 received represents 1.548% of the $15,500 invested in this play.

Moreover, if the investor can repeat this trade every 3 weeks for a year, the expected return (ER) is $4,080. That is because there are 17 periods of 3 weeks in a year (i.e., $240 x 17 = $4,080). The ER is therefore 26.3% on an annualized basis, although this assumes that there would be no obligation to buy the stock at any point.

The bottom line is that PLTR stock is worth considerably more at today's price. If its Q4 free cash flow comes in as powerful as it did during Q3, investors could potentially see the stock rise back to its peak price. One way to play this while waiting is to short OTM puts in nearby expiration periods, such as we described above.

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.