Analysts continue to raise their revenue and stock price targets for Shopify, Inc. (SHOP). Its new target price is 20% higher. This article will demonstrate how to achieve a 3.0% yield by shorting one-month away SHOP puts at a 4% out-of-the-money strike price.

SHOP closed at $146.82 on Friday, Sept. 5, with a $191.274 billion market cap. That is well over my prior target price of $137 at a 178 billion market valuation.

This can be seen in my July 13 Barchart article, just after its Q2 earnings release ("Shopify Stock is a Bargain - How to Make a 3.2% One-Month Yield with SHOP"). 

Since then, Shopify delivered strong Q2 results on Aug. 6. This article will update our prior target price based on its strong free cash flow (FCF) and FCF margins.

Free Cash Flow Margins Keep Rising

Shopify, which competes more and more with Amazon (AMZN) in the third-party online seller space, said its Q2 revenue rose 31% to $2.68 billion from $2.045 billion a year ago.

Moreover, its free cash flow (FCF), which is what is left over after all cash expenses, net working capital changes, and even capex spending, rose by +$26.7% to $422 million.

That means that, as a percent of revenue, its FCF represented 15.75% of sales (which Shopify rounds up to 16%) compared to 15.38% last quarter and 16.3% last year.

That implies that the company is continuing to squeeze out good amounts of cash from its operations, even as sales keep rising. 

Keep in mind that during Q4, Shopify tends to make significantly higher FCF margins during the Christmas season. 

For example, last Q4, its FCF margin was 21.73%, according to Stock Analysis. As a result, its look-back trailing 12 months (TTM) FCF margin as of Q2 was 18.14%, based on Stock Analysis data. In Q1, its TTM FCF margin was slightly higher at 18.42%.

Forecasting FCF

As a result, assuming the next Q4 margin will rise, we can use an 18.5% FCF margin to forecast its next 12 months (NTM) free cash flow.

Analysts now project 2025 sales will be $11.26 billion (up from $10.88 billion in my prior Barchart article). Moreover, the 2026 sales forecast is now $13.75 billion, up from $13.11 billion.

That implies that Shopify's next 12 months (NTM) revenue will be on a run rate of $12.505 billion (up from $12.0 billion in my prior article).

So, applying the 18.5% FCF margin:

   $12.505 billion NTM sales x 18.5% FCF margin = $2.3134 billion FCF NTM

That is 4.2% higher than my prior estimate of $2.22 billion.

We can use that FCF estimate to forecast its target price.

Target Price for SHOP Stock

If we assume that Shopify will eventually pay out 100% of its FCF to shareholders, and that the market will give the stock a 1.0% FCF yield, here is its valuation:

   $2.3134 billion / 0.01 = $231.34 billion market value

Today, Shopify's market cap is $191.274 billion, according to Yahoo! Finance:

  $231.34 billion /$191.274 billion = 1.2095 -1 = 20.95% upside

In other words, SHOP stock could be worth almost 21% more over the next 12 months:

  $146.82 x 1.2095 = $177.58 per share

The point is that if the company makes an 18.5% FCF margin and the market gives the stock a 1.0% FCF yield valuation, the stock could rise 21% to $177.58.

Analysts tend to agree with this. For example, AnaChart.com now shows that 34 analysts have a price target of $155.33.

One way to play this is to set a lower buy-in target price by shorting out-of-the-money (OTM) puts. That way an investor can make a good yield while waiting for the stock to fall.

Shorting OTM SHOP Puts

For example, look at the Oct. 10 expiration period, one month away (i.e., 33 days to expiration or DTE). It shows that the $141.00 put option contract, which is 4% below Friday's close, has a midpoint premium of $4.35 per put contract.

That implies that a short-seller of these puts can make an immediate yield of 3.085% (i.e., $4.35/$141.00 = 0.03085).

To do this, an investor first secures $14,100 with their brokerage firm in cash or buying power. That acts as collateral to buy 100 shares of SHOP stock, in case it falls 4% to $141.00 (each contract has 100 shares).

Then, after entering an order to “Sell to Open” 1 put contract at $141.00, the account will immediately receive $435.00. That is why this play has a 3.085% yield (i.e., $435/$14,100).

Note that the investor who does this play has a lower potential break-even buy-in point:

   $131.00- $4.35.00 = $136.65 breakeven

That is -6.92% below Friday's closing price, so it provides a good downside protection. 

Downside Risks and Alternative Options Plays

However, this only applies if SHOP falls to $141.00 and the account is assigned to buy 100 shares using the collateral already posted.

The point, however, is that an investor has a good upside this way. On the one hand, they can make an immediate yield of 3.085%. If this is repeated for three months, the expected return (ER) could be +9.255%. 

That is the same as holding shares and seeing SHOP stock rise to $160.81 over the next 3 months. Moreover, an investor could also buy deep in-the-money (ITM) calls for a further out period and use these short-put plays to help pay for the cost. That way, they may have some upside if SHOP keeps rising from here.

However, if SHOP falls below the breakeven point over the next month, an investor could end up with an unrealized capital loss. Investors can study the downside risks by going to Barchart's Option Education Center.

The bottom line is SHOP stock looks cheap here. Shorting OTM puts and/or buying ITM calls is one way to play it.

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.