Despite a recent dip in Microsoft (NASDAQ:MSFT) stock, value investors are finding enticing prospects due to the company’s substantial free cash flow and reasonable valuation metrics. Even as of September 1, 2023, MSFT stock has shown resilience, trading at $329.53, up over $2.00.
Throughout August, the stock saw a minor decline, dropping $8.16 from its July closing price of $335.92 to $327.76, a modest decrease of just 2.43%. Over the quarter since the end of June, MSFT has retreated approximately $11.00 from $340.54, accounting for a 3.2% decrease. However, on a year-to-date basis, MSFT stock has impressively surged by 37.4%, climbing from $239.82 at the end of 2022.
The Strength of Microsoft’s Free Cash Flow
In a previous analysis published on July 31, 2023, titled “Cheap Stock Alert: Microsoft and Its Huge Free Cash Flow – Options Plays Look Attractive,” we delved into Microsoft’s substantial free cash flow (FCF) and its potential impact on the stock’s upward trajectory. It’s important to note that Microsoft’s FCF margin has notably expanded.
For instance, in the fiscal fourth quarter ending June 30, 2023, Microsoft’s FCF margin reached an impressive 37.4%. This calculation is based on a quarterly adjusted FCF of $21 billion divided by quarterly revenue of $56.1 billion, indicating that over 37% of every dollar in revenue directly contributes to its balance sheet. Importantly, this FCF remains unencumbered even after accounting for capital expenditures, working capital requirements, and all cash-related expenses, making it available for dividends, share buybacks, acquisitions, and more.
Microsoft boasts one of the tech industry’s highest FCF margins, standing at 37.4%. In comparison, even technology giants like Alphabet (GOOG) generated lower FCF margins of just 31.25% in Q2, and Apple (AAPL) reported FCF margins of 29.7% in its most recent quarterly earnings.
Investors are closely monitoring Microsoft’s valuation as a result of these remarkable FCF figures.
MSFT Stock Remains Attractive
In the previous analysis of MSFT stock on July 31, we presented a scenario where Microsoft could potentially generate $100 billion in free cash flow by the year ending June 30, 2024. Utilizing a conservative 3.0% FCF yield, this projection suggests that Microsoft’s market capitalization could reach $3.33 trillion, marking a gain of 36.6% over its present market capitalization of $2.44 trillion.
In simpler terms, MSFT stock could theoretically be valued at as much as $450 per share, reflecting a 36.6% increase from its current price of $329.53. It’s important to note that this valuation is not guaranteed.
For those who prefer a more conservative approach, a 3.5% FCF yield could still result in a market capitalization of $2.857 billion, representing a 17% increase over the current price and implying a price target of $385.55 per share. These figures continue to make MSFT stock appealing to value investors for the next year.
Enhancing Returns with Shorting OTM Puts
Investors can further boost their income by shorting out-of-the-money (OTM) put options. For instance, with an expiration date of September 29, which is 28 days away, the $310 strike price is an attractive option. These puts, priced at $1.63 per contract, sit 5.78% below the current spot price, offering traders a monthly income of 0.526% and an annualized return of 6.30%. This strategy can be particularly beneficial for existing MSFT stockholders looking to augment their modest 0.82% annual dividend yield.
To execute this strategy, traders would secure $31,000 in cash or margin with their brokerage firm and “Sell to Open” 1 put contract at the $310 strike price with a September 29 expiration. This would result in an immediate income of $163.00 per put contract sold short. If this trade and yield can be repeated monthly for a year, investors could earn an additional $1,956, translating to a return on investment (ROI) of 6.30%.
While there are no guarantees that this trade can be consistently repeated, it demonstrates the potential rate of return available by shorting OTM puts on MSFT stock. Additionally, even if the stock dips below $310, investors would acquire more shares at a lower price, potentially reducing their average buy-in cost. Furthermore, traders can hedge against potential losses from the exercise of put options by shorting OTM calls with the acquired shares.
In summary, this approach presents a compelling strategy to capitalize on MSFT stock’s potential upside, particularly appealing to MSFT shareholders seeking to bolster their dividend yield within this highly profitable company.
Featured Image: Pixabay
Author Faith Yakubu