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Block Inc (SQ) stock shows unusual activity today in near-term out-of-the-money (OTM) put options. Block Inc. is the parent of Square and Cash App. The company recently reported strong Q2 results including positive free cash flow (FCF) growth over the last year.
This OTM put options trading volume highlights the underlying value of SQ stock. This article will show why SQ stock could be undervalued by 30% to 40%. That sets its minimum price target at $83.72.
In midday trading, SQ stock is trading at $64.40 today. The Barchart Unusual Stock Options Activity Report today shows that almost 10,000 put options contracts have traded at the $62.00 strike price. That put options strike price is for expiration in 9 days on Sept. 13.
So, in effect, some large institutional investors are betting either that SQ stock will fall (i.e., put buyers) to below $62, or short-sellers are happy to bet that it won't.
The short-put investors are collecting 91 cents per put contract sold short. That provides an immediate yield of almost 1.5% (i.e., $0.91/$62.00 = 0.01468) for just 9 days at a strike price that is 3.73% out-of-the-money (i.e., $62/$64.40-1 = -0.37266). That means they are confident that SQ stock may stay flat over the next 9 days, or at least that it won't fall below $61.09 (i.e., $62.00-0.91), which is about 5.1% below today's price.
Moreover, that level of income works out to a monthly yield of almost 5% (i.e., 31 days/9 x 0.01448 = 0.04888), assuming the trade can be repeated over 3 times a month.
Put option buyers here may also not necessarily be completely negative on SQ stock. Some hedge funds may be hedging their long positions on their long positions in SQ stock.
After all, Block Inc. produced fairly strong results and SQ stock could be undervalued in the long-term. Let's look at that.
Underlying Value of SQ Stock
Block reported on Aug. 1 that its Q2 revenue rose 11.2% YoY and six-month revenue was up 15% YoY. Moreover, its adjusted EBITDA (earnings before interest, taxes, depreciation, and taxes), a cash flow metric, was $759 million. That was 7.66% higher than the prior quarter and also represented a very high 34% of revenue.
More importantly, Block said its adj. operating income, a good measure of its profitability, was $399 million, up 9.6% QoQ, and with a 17% margin on revenue. This implies that the company is now generating significant amounts of free cash flow (FCF).
For example, Block reported that in the last year its adj. FCF was $1.43 billion, well over twice the $606 million in the prior year period. That represents 6.08% of its last 12-month (LTM) revenue of $23.5 billion. That implies that the company could generate significant cash flow going forward.
For example, analysts now project that Block will make $27.59 billion in revenue next year, up 11.5% in project 2024 revenue of $24.75 billion. As a result, if Block keeps generating 6% adj. FCF margins it could produce as much as $1.66 billion in adj. free cash flow (i.e., 0.06 x $27.59b = $1.6554 billion).
Price Target for SQ Stock
That implies that its underlying value could be significantly higher. For example, the market is presently valuing SQ stock with a 3.6% FCF yield since its market cap is almost $40 billion (i.e., $1.43b adj. LTM FCF/$39.5 billion market cap).
Therefore, using a 3.5% FCF yield (assuming that the market improves the valuation metric), SQ stock could have a $47.3 billion market cap (i.e., $1.655b/0.035) in the next year. Moreover, using a 3.0% FCF yield, the market cap could rise to $55.16 billion. These projections are between 20% and 40% higher than today's $39.5 billion market cap.
In other words, on average, the stock is about 30% too cheap. That means it could be worth almost $84 per share (i.e., 1.30 x $64.40 today = $83.72).
That could be one reason why investors are shorting out-of-the-money put options today in SQ stock.
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.
