Microsoft (MSFT) stock has spiked since its late Oct earnings report. But its powerful free cash flow (FCF) implies it could be worth significantly more, over $446 per share, or 21% over today’s price of $369 in morning trading on Nov. 14.
I discussed the company’s FCF generation in my Oct. 27 Barchart article, “Microsoft Could Make $100 Billion in Free Cash Flow, Leaving MSFT Stock Undervalued.”
FCF Could Reach $100 Billion
I based the prediction of $100 billion in FCF for this year on a 37% FCF margin (i.e., FCF/sales) estimate and sales forecasts for the year ending Sept. 30, 2023, and 2024.
For example, analysts surveyed by Seeking Alpha project sales will hit $242.69 billion this year and $276.21 billion next year. That means the average 12-month forward sales will be about $260 billion.
So, if we apply the 37% FCF margin Microsoft generated in the last 2 quarters to this sales estimate, we get a forecast of $96.2 billion in FCF for the next 12 months. I have rounded that up to $100 billion assuming earnings and cash flow continue to grow.
This means MSFT stock could be worth significantly more than where it is today.
MSFT Stock Could Be Worth Over $446
For example, using a 3% FCF yield metric implies that its $100 billion in FCF makes Microsoft worth $3.33 trillion (i.e., $100b/0.033). This is also the same as multiplying the FCF by 33.3x.
Since Microsoft’s market capitalization today is just $2.75 trillion, MSFT stock could rise by 21% (i.e., $3.33 trillion/$2.75 tr).
So, multiplying today’s price of $269 by 1.21, we get a price target of $446.49 per share.
And keep in mind that Microsoft also has a large share repurchase program. It has a plan to buy back $60 billion in shares and in the last quarter, it spent $3.6 billion. That works out to $14.4 billion annually.
That represents just 0.52% of its present market cap, so it shows that the company has plenty more room to buy back shares.
Shorting OTM Puts for Existing Shareholders Creates Additional Income
Since MSFT’s dividend yield is so low (below 1.0%), existing shareholders may want to create pseudo income while they wait for the higher stock price. For example, in my last article, I recommended that shareholders sell short the $320 strike price for the period ending Nov. 17 (this coming Friday).
At the time, with just 3 weeks to expiration, the premium collected was $3.18, or about a 1% yield (i.e., $3.18/$320 strike price). There was not much risk as well since the put strike price was over 4% out-of-the-money (OTM).
Today, those puts are set to expire worthless, so this was a good trade and the investor who sold these puts short kept the premium and made a good yield.
Today, for the Dec. 8 expiration period, just over 3 weeks from today, the $355 strike price puts (3.8% below the spot price) trade for $2.34. That represents a good yield of 0.66% (i.e., $2.34/$355).
MSFT Puts expiring 12/8/23 – Barchart – As of Nov. 14, 2023
This means that if the investor can repeat this trade every 3 weeks for a year, they can make a total expected return of 11.2% (i.e., .00659x 17). Obviously, there is no guarantee that this can be repeated each period, but it highlights the potential upside in shorting OTM puts.
The advantage to existing shareholders is that there is no risk of having to give up their existing shares.
The worst that will happen, should MSFT fall to $355 or lower by Dec. 8, is that the investor will have to buy more shares at the strike price. That could lead to an unrealized loss, or serve to increase the investor’s long-term average cost in the stock.
Nevertheless, the company has very powerful free cash flow and FCF margins. It is only using a portion of these for dividends and buybacks. Therefore, it makes sense to short near-term OTM puts for additional income.
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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.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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