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Palo Alto Networks (PANW) stock could still be cheap based on its strong free cash flow (FCF) results and after its 2-for-1 stock split has gone into effect. Investors who short out-of-the-money (OTM) put options can make income as well.
PANW stock is now at $202.72 on Dec. 17, after its 2-for-1 stock split occurred on Dec. 12., with the price about half of what it was before. But actually, it has risen over 3.5% since Nov. 20 when the announcement was made and PANW stock was at $196.45 (on an adjusted basis).
Moreover, PANW may have more upside, based on both its strong FCF results and analysts' target prices.
PANW's Value Based on FCF
I discussed the company's recent results and its value in my Nov. 29 Barchart article, “Palo Alto Networks Delivers Huge Free Cash Flow Margins and Stock Split.”
I argued that the stock could be worth $456 (now after the stock split, $228 per share), based on a revenue estimate of almost $10 billion for the next 12 months (NTM) (actually $9.865 billion) as well as a 38% FCF margin, based on management's estimates.
That results in an NTM FCF estimate of about $3.75 billion. Using a 2.5% FCF yield metric results in an NTM market cap of $150 billion (i.e., $3.75b/0.025).
(Note that the NTM market cap estimate is not affected by the stock split). Today, the market cap is $132.95 billion. So, there is still 13% upside to its true value:
$150b NTM mkt cap / $132.95b -1 = 0.128 = +12.8%
So, at today's price of $202.72, PANW is still worth 12.8% more, or $228.62 per share.
Analyst Price Targets
Since the recent earnings were released, analysts have raised their price targets. For example, in my last Barchart article on Nov. 29, the analyst survey by AnaChart.com said that 35 analysts had an average of $412.52, i.e., $205.26 after the split.
Today, those analysts have an average price target of $230.65. So, on average they have raised their target prices by 23.6% since the earnings were released.
The bottom line here is that analysts and an analysis based on the stock's underlying value show that PANW stock is still undervalued.
One way to play this is to set a lower buy-in target price by selling short out-of-the-money (OTM) strike prices in near-term expiry periods.
Shorting Out-of-the-money (OTM) Puts in PANW Stock
For example, look at the Jan. 17, 2025, expiration period, one month from now. It shows that the $190 strike price put options contract has a bid-side premium of $2.33 per put contract.
That means that a short-seller of these puts can make an immediate yield of 1.226% over the next month (i.e., $2.33/$190.00).
This means that the investor first must secure $19,000 in cash or buying power with their brokerage firm. Then they enter an order to “Sell to Open” 1 put contract at $190 expiring Jan. 17, 2025, on the bid side. This is known as a cash-secured put option play, as the cash acts as collateral in case the put is exercised upon falling to $190 on or before Jan. 17, 2025.
The account should then immediately receive $233.00 (i.e., 100 shares per contract x $2.33 premium). That is why the investment makes an immediate yield of 1.23% (i.e., $233/$19,000).
Moreover, as long as PANW stock stays over $190, which has a delta ratio of -0.215, or about a 21.5% chance of that happening over the next month, the account will not be assigned to buy 100 shares at $190.00 per share.
The bottom line is that while waiting for the stock to get cheaper a value investor can make a good yield. Even if that happens the investor following this play actually has a lower breakeven price of $190-$2.33, or $187.67, which is 7.34% below today's trading price. That makes this kind of play attractive to value buyers.
