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HomeStock MarketBroadcom Looks Deeply Undervalued Based on its Strong Free Cash Flow

Broadcom Looks Deeply Undervalued Based on its Strong Free Cash Flow

Broadcom Inc. (AVGO) stock still looks very cheap today, based on its free cash flow (FCF) and related FCF margins. As a result, AVGO The stock could be worth over 22% more at $1,626 per share. This is a result of projecting next year’s FCF using its existing FCF margins and applying a 3% FCF yield metric.

I discussed this in my last Barchart article on March 31, “Broadcom’s Free Cash Flow Could Value AVGO Stock 21% Higher – Good for Short-Put Investors.” At the time, AVGO stock was at $1,325.41, and on Friday, May 10, AVGO closed at $1,332.80.

Previous Short Put Play

In the article, I wrote that AVGO was worth at least $1,607.72 per share and I suggested shorting the $1,300 strike price put option expiring on April 19. As it turns out AVGO stock closed at $1,204.71, which was a recent low. 

Any investor who shorted puts at $1,300 would have had to buy shares at $1,300 per share, but they would have also received $26.00 in put premiums. That means their breakeven cost was just $1,274.00. For a time the short put investor would have had an unrealized loss. But today, they now have a 4.45% gain.

That shows that using short put plays is a good way to buy into a stock that is deemed undervalued like Broadcom. Let’s review why that is the case.

Broadcom’s Strong Free Cash Flow and Margins

Broadcom is a semiconductor design company focused on artificial intelligence (AI) applications. That is powering its revenue and strong profitability. For example, last quarter ending Feb. 4, the company’s revenue rose +34% Y/Y to $11.96 billion and its free cash flow (FCF) was up +19.2% to $4.693 billion.

That means that its FCF margin for the quarter was high at 39.2% (i.e., $4.7b/$12.0 billion). Moreover, in the trailing 12 months to Feb. 4, its FCF margin was higher at 45.3% based on data from Seeking Alpha (i.e., $17.6 billion in FCF / $38.865 b revenue).

In other words, we can expect that the company could easily generate 40% FCF margins going forward. But just to be conservative, let’s use its recent 39.2% FCF margin to forecast FCF. 

For example, analysts expect that next year ending Oct. 2025, revenue could rise to $57.67 billion. Applying a 39.2% FCF margin to this results in an FCF forecast of $22.6 billion. 

That is useful for setting a price target for Broadcom stock.

Price Target for AVGO Stock

For example, if we assume that the market will value this FCF with a 3.0% FCF yield metric, the market value will rise to $753.3 billion (i.e., $22.6b FCF/0.03). That is the same as multiplying the FCF estimate by 33.3x.

This $753.3 billion market value estimate is 22% higher than its present market capitalization of $617.65 billion. In other words, AVGO stock could be worth 22% more than Friday’s price of $1,332.80, or $1,626 per share.

Other analysts tend to agree. For example, Yahoo! Finance, which uses Refinitiv data, reports that the average of 28 analysts’ price targets is $1,524.90 per share. That is over 14.4% higher. Moreover, AnaChart, a new sell-side analyst tracking service, says that 23 analysts have an average price target of $1463.57. This is a potential upside of $130.77 (9.81%) from the May 10 price of $1332.80. The bottom line is that everyone is projecting higher prices for AVGO.

This is useful for investors who short out-of-the-money puts to set a buy-in target price, as well as gain extra income.

Shorting OTM Puts

For example, look at the May 31 expiration period, about 3 weeks away. The $1,290 strike price, which is 3.2% below the spot price on Friday, has a premium of $22.30 on the bid side. That means that short put plays can yield 1.73% or so (i.e., $22.30/$1,290.00), depending on how it trades when the market opens on Monday.

AVGO puts expiring May 31 – Barchart – As of May 10, 2024

The bottom line is that an investor who sell short put options at $1,290 can be assured that even if the stock falls, their breakeven buy-in cost will be $1,267.70 (i.e., $1,290 – $22.30). That breakeven cost is over 4.1% below the price on May 10, providing good downside protection.

Moreover, if the stock rises to the projected price targets shown above the investor can make good money. Even if the stock stays flat the investor can roll these put plays over to generate extra income. 

For example, if this play can be repeated 4 times over the next 90 days, the expected return (ER) is almost 7% (i.e., 1.73% x 4 = 6.92%). That is a good yield for any investor, especially if they already own shares in Broadcom stock.

More Stock Market News from Barchart

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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