Snowflake Inc. (SNOW) reported strong revenue and free cash flow in Q3 on November 20. It also provided enough guidance to allow analysts to forecast a Q4 44% FCF margin. Therefore, using its historical 1.5% FCF yield metric SNOW stock could be worth over 26% more at $232 per share.

SNOW closed at $183.64 on Friday, Dec. 6, up over 42% since releasing earnings after it closed at $129.12 on Nov. 20. The market liked what it read about the company's forecast outlook for FY 2025 (ending Jan. 31, 2025).

But is it a peak? The chart below shows that SNOW stock has been spiraling upwards. It may not be. This article will discuss why.

For one, it's possible to forecast next year's revenue and free cash flow (FCF) for the cloud-based data storage company that provides data analysis platforms and access to public clouds.

Forecasting SNOW's FCF

I discussed how to do this in a Dec. 4, 2024, GuruFocus article, “Snowflake Inc Projects Huge FCF Margins This Year.” This was based on management's forecasts for two areas:

•  adjusted FCF margins for FY 2025 (i.e., ending Jan. 31, 2025) will be 26%
• product revenue will rise 23% YoY

For example, the article shows how you can reverse engineer Snowflake's Q4 adj. FCF margins. The article shows it will be 44% (compared to 42% last year). 

More importantly, based on analysts' forecasts for next year, FCF could rise substantially. Here's how. 

             1. Analysts forecast revenue next year will be $4.42 billion, based on Seeking Alpha's survey of 45 analysts.

             2. Using management's 26% adj. FCF margin for FY 2025, shows that FCF could be $1.15 billion:              

                         $4.42 b FY 26 revenue est. x 0.26 FCF margin = $1.149 b

              3. That is +23% higher than the $935 million in FCF projected for FY 2025

As a result, we can use this to value SNOW stock.

Target Prices

Historically SNOW stock has traded at a market cap with a 1.5% FCF yield. That means its free cash flow as a percent of its market value has averaged 1.5%. 

In other words, assuming that Snowflake paid out 100% of its FCF as a dividend, the market would give SNOW stock a 1.5% dividend yield.

Therefore, we can use that to value SNOW stock's future value. Here is how that works:

          1. Divide FY 2026 adj. FCF by the 1.5% FCY yield:

                     $1.149 b/ 0.015 = $76.6 billion est. mkt cap in the next 12 months

          2.  Divide this result by today's market value:

                     $76.6 b forecast mkt cap / $60.6 b today = 1.264 = +26.4% higher

          3.  Multiply this factor by today's price per share:

                    $183.64 x 1.264 = $232.12

So, using a 1.5% FCF yield, and assuming Snowflake makes a 26% FCF margin as its management project for this year, SNOW is still worth considerably more. Moreover, analysts agree.

Analysts Agree SNOW is Undervalued

For example, AnaChart.com, a site that tracks sell-side analysts' price targets, shows that 40 analysts have an average price target of $209.66 per share.

Moreover, several analysts have substantially raised their price targets in the last 2 weeks since the company released its Q3 earnings and provided guidance.

The table above shows that two analysts have raised their price targets to $200 or higher. Many of these analysts have higher-than-average track records, with their “Price Targets Met Ratio” metrics being greater than 50% of the time.

The bottom line is that analysts seem to be warming up to SNOW stock's potential upside.  

One way to play this is to sell short out-of-the-money (OTM) put options in nearby expiry periods. That way, if SNOW stock falls in the near term, an investor can set a lower buy-in target and also get paid while waiting.

Shorting OTM Puts

For example, the Jan. 3, 2025, expiration period, which is 27 days from now, shows a very attractive out-of-the-money (OTM) short-put yield play. Investors who short these puts can make a 3-week yield of over 1.6% and set a lower buy-in price target.

Here's how that works. Look at the $175.00 strike price for the put option chain. That price is 4.7% below (i.e., out-of-the-money) Friday's trading price of $183.64. In other words, it provides some downside protection.

The short seller of puts at this strike put options can make an immediate 1.69% yield over the next three weeks. This is because the bid-side premium for the put is almost $3.00:

        $2.96 put premium / $175.00 strike price = 0.01691 ……….. i.e., a 3-week 1.69% short-put yield

Here is how that works on a practical basis. An investor secures $17,500 in cash or buying power with their brokerage firm. That acts as collateral in case SNOW falls 4.7% to $175.00 anytime through Jan. 3. In that case the account will be assigned to buy 100 shares at $175.00, hence the cash-secured collateral of $17,500.

Next, the investor enters a trade to “Sell to Open” 1 put contract at the $175.00 strike price for expiry on Jan. 3. If the brokerage firm fills the trade at the bid side of $2.96, the account will immediately receive $296.00 (i.e., given that 1 put contract represents 100 shares).

Therefore, for an investment of $17,500, the account just made $296.00. Hence, the 1.69% yield calculation. No matter what happens, even if the stock price falls to $175.00 or lower, the account keeps that $296.00.

Downside Risks and Issues

As a result, the investor has a lower buy-in price target. Note that the breakeven level is actually 6.3% lower than Friday's trading price:

    $175.00 strike price - $2.96 income received = $172.04 p/ sh

    $172.04 / $183.64 -1 = 0.93683 -1 = -0.06316 = -6.3% lower breakeven price

That provides some downside risk protection, i.e., it could help defray against any unrealized loss if SNOW falls to $175.00 and the put option trade is assigned to buy 100 shares.

Moreover, the investor will now own 100 shares at $172.04. Given our $232 price target (see above), this provides an expected return of +34.85%.

In addition, even if that doesn't happen, the investor can always short SNOW puts again at OTM strike prices. For example, if the investor can make this same 1.69% yield over 3 months, the expected return (ER) is over 5.6%:

   90 days/27 Days to expiry  = 3.33

   3.33 x 0.0169 = 0.0563 = +5.63% ER over 3 months

So, the investor can make extra income while waiting to buy into SNOW stock. Moreover, for investors who already own SNOW shares, this provides a way to gain extra income as well as make any upside in SNOW stock. If the stock falls the income helps defray against any unrealized losses.

The bottom line is that SNOW stock looks undervalued here. One way to play it is to short-sell OTM puts in nearby expiry periods.

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.