Amidst Meta’s (NASDAQ:META) substantial free cash flow (FCF) generation, its stock is likely undervalued by at least 30%. Leveraging a valuation based on a 40% FCF margin and a 5% FCF yield metric, a strategic income approach involves shorting near-term out-of-the-money (OTM) put options.
An illustrative example involves shorting the Nov. 17 $275.00 strike price put option, which generated immediate income for the short seller. This income strategy capitalizes on Meta’s undervaluation, allowing investors to generate returns.
Meta’s impressive FCF performance was highlighted in the last quarter, where it generated $13.6 billion in FCF with a 40% FCF margin on $34.1 billion in revenue. Projections for the next year estimate a massive FCF ranging between $53.3 billion and $60.2 billion, averaging $56.8 billion. Applying a conservative 5% FCF yield metric suggests a potential market cap of $1.135 trillion, indicating a 30.5% rise over the current market cap of $870.1 billion.
While holding Meta stock long-term seems logical, the absence of dividends prompts consideration of alternative income strategies. Shorting OTM emerges as an option, particularly in near-term expiration periods. In this case, the focus is on the expiration period ending Dec. 22, approximately three weeks away.
We are examining the $325 strike price puts, over 4% OTM, trading at $3.55 on the bid side, presenting an immediate income yield of 1.09% to the short seller. With the potential to repeat this strategy monthly, the expected annual return exceeds 13%.
Practically, an investor secures $32,500 in cash or margin, then initiates a “Sell to Open” order for one put contract at the $325 strike price for expiration on Dec. 22. The account immediately receives $355 (100 shares x $3.55), representing over 1% of the invested amount. If Meta stock stays above $325, the investor’s funds won’t be automatically used to buy shares at $325, providing a breakeven price of $321.45 and over 5% downside protection.
In summary, Meta stock’s potential undervaluation of 30% offers an opportunity for existing shareholders to wait patiently for appreciation while employing an income-generating strategy through shorting OTM puts.
Featured Image: Unsplash
