Nvidia Inc. (NVDA) reported strong Q3 free cash flow margins and analysts have raised their revenue forecasts. This means NVDA stock could be undervalued by 26% with a price target of $179 per share. Shorting OTM puts is attracting interest.

NVDA is at $142.19 in midday trading on Friday, Nov. 22. This is down from its recent peak of $148.88 on Nov. 7. It's been treading water, but could be due for a rebound, based on its strong results.

For example, value investors see Nvidia's strong FCF margins and believe it could be worth substantially more. Let's look at why.

Strong FCF Results

On Nov. 20, Nvidia reported that for the quarter ending Oct. 27, 2024, its free cash flow (FCF) hit $16.8 billion and revenue was $35.1 billion. Both of these figures are peak results. More importantly, its FCF margins also rose (see the table below).

This shows that almost half (47.85%) of its revenue is converted into cash flow that is “free” of any cash obligations. It goes straight into the company's checking account. FCF is leftover cash flow after all cash spending. That includes cash expenses on the income statement, as well as capital expenditures and net working capital flows, both on the cash flow statement.

The bottom line is that the company is a cash-generating cash cow. Moreover, the portion of revenue becoming FCF is increasing. This implies that its operating leverage is increasing. 

That is why NVDA stock is worth much more. Let's look at why.

Projecting FCF for 2025

Analysts have raised their 2025 revenue forecasts since the Q3 earnings release. For example, in my prior Barchart article, I wrote on Nov. 5 that analysts had an average revenue forecast of $177.89 billion. Now they are projecting $192.48 billion for 2024, up +8.2%.

As a result, we can project a much higher free cash flow for 2025. For example, to be conservative, let's use a lower 46% FCF margin. This results in an $88.5 billion FCF forecast:

   $192.48 billion (2025 sales forecast average) x 0.46 (FCF margin) = $88.54 billion FCF

This FCF is $30 billion higher than the $56.5 billion in FCF made in the last 12 months (LTM) (Seeking Alpha data). It implies that free cash flow could rise over 56% in the coming year. That could push NVDA stock much higher. Let's estimate that.

Setting a Price Target

One way to set a valuation target price is to assume that 100% of its free cash flow will be paid out to shareholders. What will the market do? What yield will the stock have?

NVDA could end up with a 2.0% dividend yield based on its historical FCF yield figures and comp metrics. Here is how to reverse engineer its market cap:

   $88.54 billion FCF in 2025 / 0.02 = $4,427 billion market cap (i.e., $4.4 trillion)

This is 26% higher than its market cap today of $3.505 trillion.

In other words, NVDA stock is worth 26% more or $179 per share (i.e., $142.19 x 1.26 = $179.16).

Analysts Agree 

Analysts have raised their price targets as well. For example, Yahoo! Finance's survey of 64 analysts has an average price target of $170.44, or 20% higher.

Moreover, AnaChart.com, which tracks analysts' price targets as if they are stocks, shows that the average of 39 analysts is $176.47, or +24% higher. That is very close to my $179 price target.

In addition, the table below shows that many analysts have now raised their price targets.

Note that many of these analysts have good track records. Most of these analysts have “Price Targets Met Ratio” metrics greater than 90%. That means their price targets have worked out 90% of the time.

One way investors find it interesting to play this is to set a lower buy-in target by selling short out-of-the-money (OTM) puts. That way they can accumulate income while waiting for NVDA to fall to a lower price at which the short seller would be obligated to buy the shares.

Shorting OTM Puts

I discussed this in my Nov. 5 Barchart article, “Nvidia Put Options Premiums are Sky-High - Good for Short Sellers Ahead of Earnings.” I suggested that the $130 strike price puts expiring today on Nov. 22 were cheap at $4.00.

Today those puts are almost worthless. That means the 3.077% in income that the investor made immediately has worked out well (i.e., $4.00 / $130.00 = 3.077%), with less than 3 weeks until expiration. The investor will not be obligated to buy shares at $130. (Note at the time the delta ratio was -29% - i.e., there was less than a 30% chance that the investor would be forced to buy at that strike price).

Today, put options expiring Dec. 13 (i.e., three weeks away) with a similar delta ratio, are trading for $3.05 per put contract. That is the bid side premium for the $137.00 strike price expiring Dec. 13 with a -31% delta ratio.

This gives short-put investors an immediate yield of 2.22% (i.e., $3.05/$137.00).

Note that the strike price is about 4.6% out-of-the-money - i.e., below today's trading price. So, this provides some downside protection.

For example, even if NVDA falls to $137.00 in the next 3 weeks, and the investor is obligated to use the cash secured to buy shares at $137.00, the breakeven price would still be lower by $3.05 (i.e., $137.00 - $3.05 = $133.95). 

In other words, the investor has a 5.79% downside protection. Moreover, the investor can defray any potential unrealized loss if this occurs by shorting OTM puts in the future. 

The bottom line is that this is a good way to set a lower buy-in target price. NVDA stock looks undervalued over the next year due to its huge FCF and FCF margins. This OTM short-put play is attractive to value investors.

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.