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The Rise of Broadcom: Unveiling the Potential of AVGO Stock Amidst Impressive Free Cash Flow Margins

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The Blinking Light on Free Cash Flow and Margins

When Broadcom Inc. (AVGO) divulged its fiscal Q1 results, the market buzzed with excitement. The semiconductor giant saw its revenue escalate by a whopping 34% Year-over-Year (YoY) to $11.96 billion – surpassing estimates by a staggering $240 million. Beyond the revenue surge, the real jaw-dropper was the surge in free cash flow (FCF), climbing 19.3% from $3.933 billion to $4.693 billion during the quarter.

However, the real kicker was the FCF margin – a triumphant 39% of revenue. Undoubtedly, a remarkable accomplishment though slightly edged down from the 44% margin a year earlier. Moreover, the prior quarter boasted a slightly higher FCF margin of 50.8%, undoubtedly casting a shadow over the latest figures. Market sentiment was somewhat lukewarm post-announcement, signaling a desire for even higher margins. Nevertheless, despite these reactions, analysts believe that AVGO stock remains significantly undervalued.

Crunching the Numbers: Target Price Evaluation for AVGO Stock

Broadcom’s forward-looking statements outlined revenue projections to soar to around $56.86 billion next fiscal year from the current milestone of $50 billion this fiscal year ending October 2024. Additionally, management hinted at adjusted EBITDA being 60% of revenue, pinpointing a notable NTM run rate adj. EBITDA of $32.1 billion.

This financial forecast serves as a crystal ball to project FCF. For instance, the last quarter witnessed an adj. EBITDA of Β $7.156 billion translating into $4.693 billion in FCF, marking a ratio of nearly 65.6%. This indicator hints at a projected run rate FCF for the upcoming 12 months (NTM) of $21 billion – a considerable pool for dividends with the payout ratio for the preceding quarter pegged at 52% ($2.435 billion distributed out of $4.693 billion FCF).

Computing further with the current 1.6% dividend yield, carving out expectations of $10.92 billion in dividends in the coming year out of the $21 billion FCF pot results in a potential market cap of $682.5 billion. A remarkable 12.5% gain beckons when juxtaposed against the existing $606.5 billion market cap. A simpler valuation method places the projected market cap at $752 billion, up by over 24%, pronouncing AVGO stock’s possible worth at 18% more, around $1,544 per share.

Shorting OTM Puts: A Strategic Move for Income Generation

Existing AVGO shareholders are presented with a tactical move to enhance income – selling short out-of-the-money put options. For instance, scrutinizing the options market spotlighting the March 28 expiration period reveals astronomical put premiums.

The $1,270 strike price put option sits 3% below the current price with a $36.30 bid side premium per contract, equating to a 2.85% income return in under 3 weeks for the short seller.

While this avenue demands an upfront investment of $127,000 (i.e., $1,270 x 100) to secure immediate earnings of $3,600 (i.e., $36 x 100 share per put contract), ample protection is pledged from the downside. The underlying stock would have to plummet to $1,233.70 ($1,270 – $36.30), which is 5.7% below today’s price before any capital loss looms, even post assignment.

In conclusion, AVGO stock shines with an undervalued gleam. Shareholders can leverage high put option premiums to enhance returns through shorting tactics.

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Mark R. Hake, CFA does not hold positions in any securities specified in this article. The article is provided for informational purposes only. Review the Barchart Disclosure Policy for further information.

The opinions conveyed in this article belong to the author and are not necessarily the views held by Nasdaq, Inc.

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