Amazon (AMZN) is once again generating free cash flow based on its latest quarterly results. Based on 2024 earnings estimates and a 4% FCF margin, AMZN could rise 23% to $181.52 per share using a conservative FCF yield metric.
One way to play this is to sell short near-term expiration out-of-the-money (OTM) put options. This allows existing shareholders to generate income, as Amazon does not yet pay a dividend to its shareholders. This is despite its positive free cash flow (FCF) generation. (It also doesn’t buy back shares.)
Amazon’s Free Cash Flow Could Increase
I discussed Amazon’s potential premium in my Nov. 7 Barchart article, “Amazon’s Huge Increase in Positive Free Cash Flow Bodes Well for AMZN Stock.”
For example, last quarter it earned $21.4 billion in FCF over the last 12 months (LTM). That represented 3.8% of its LTM revenue of $554 billion.
Using a 4% FCF margin (rounding, assuming improvement) based on its next 12 month sales (NTM), we can estimate free cash flow going forward.
For example, analysts now forecast $635.7 billion in sales during 2024. This implies that Amazon’s NTM FCF could be $25.4 billion (ie 0.04 x $635.7 billion).
AMZN Share Could Be Worth More Than $181 Per Share
This implies that AMZN stock could go higher from here. For example, using a yield metric of 1.5% FCF, AMZN would be worth $1.693 billion (ie, $25.4b / 0.15). This is the same FCF yield that the stock currently has.
However, with the higher FCF levels, the market could raise its valuation metric. So, using a 1.25% FCF yield, the stock would be worth $2.032 billion (ie, $25.4b / 0.0125).
Since AMZN has a market cap of $1.51 trillion, this shows that the stock could rise between 12.1% (ie, $1.693 billion market cap) and 34.6% (ie $2.032 billion). On average, this is a possible 23% more.
In other words, AMZN stock could be worth 23% more than its current price of $147.58 per share. That sets its price target at $181.52.
Sell Short Near OTM Puts for Income
One way to play this is to sell short near-term expiration put options to generate income. That’s because AMZN stock doesn’t pay a dividend yet. That way shareholders can be paid to wait for the stock to go up.
With short puts there is no danger that your stock will be sold, as with covered call plays.
For example, look at the December 15 option expiration period. This shows that the strike price of $140, which is 4.57% below today’s price (ie, is out-of-the-money OTM), is trading for 85 cents per contract.
That provides an immediate income of 0.607% for the short seller (ie $0.85 / $140). If this trade repeats every 3 weeks for a year, the expected return is 10.3% (ie, 0.607% x 17x). That is because there are 17 periods of 3 weeks in a year.
If an investor wants to take a little more risk, they could short the $142 puts. That provides an income of $1.25 per contract, or an immediate return of 0.88% (ie, $0.88/$142). But if AMZN fell to $142, the investor’s cash security of $14,200 per contract shorted would be used to buy 100 shares at $142.
The bottom line is that AMZN shareholders have more ways to profitably expect AMZN stock to rise, given its huge free cash flow.
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As of 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 for informational purposes only. For more information, please see Barchart’s Disclosure Policy here.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.