Palo Alto Networks (PANW) generated over $3 billion in free cash flow (FCF)over the trailing 12 months (TTM) ending April 30, over 33.8% of TTM sales. That makes PANW stock look attractive here to value buyers. 

Moreover, selling short out-of-the-money (OTM) put options is a way to set a lower buy-in target and get paid while waiting. PANW is at $186.08 in midday trading on Friday, May 23. 

That is lower than its pre-earnings price on May 20 of $194.48. 

However, as this article will show, PANW stock could be worth +13.5% more at $211 per share over the next year based on its strong FCF margins.

Palo Alto Networks' Strong Free Cash Flow and FCF Margins

Palo Alto Networks, the cybersecurity solutions company, reported that its fiscal Q3 ending April 30 resulted in 15% higher revenue YoY at $2.289 billion. More importantly, the company reported that its adjusted free cash flow (FCF) was $578.4 million (seen on page 7 of its supplementary data release).

It represented 25.2% of fiscal Q3 revenues. But, as can be seen in the table from the company below, this is not as important as its trailing 12-month (TTM) FCF margin.

It shows that subscription revenue and FCF peak in fiscal Q1. So, it's important to recognise Palo Alto Networks' TTM FCF and FCF margins.

For example, its TTM revenue was $8.874 billion, and its FCF over the last 4 quarters was $3.0 billion. That means its TTM FCF margin was 33.8%:

  $3.0b FCF / $8.874b revenue = 0.338 = 33.8%

That was slightly lower than a year ago (fiscal Q3 2024)

  $3.01b FCF/ $7.79b revenue = 38.6%

However, it was roughly on par with fiscal Q2 2025 (i.e., LTM ending Jan. 31, 2025):

  $2.93b FCF / $8.57b revenue = 34.2%

The point is that the company is consistently generating very high free cash flow margins. So much so that it is one of the only or few companies that projects out their full year FCF margins.

For example, here is what management said about its fiscal year 2025 guidance:

  "For the fiscal year 2025, we expect:

• Total revenue in the range of $9.17 billion to $9.19 billion, representing year-over-year growth of 14%.
• Adjusted free cash flow margin in the range of 37.5% to 38.0%."

This is very unique. Almost no company can confidently predict its FCF margins for a full fiscal year. That should give investors and analysts confidence in valuing PANW stock.

Price Targets for PANW Stock

For example, analysts project revenue for FY 2025 (ending July 31) will be $9.19 billion, and next year FY 2026, the forecast is for $10.5 billion. That means its run rate next 12-month (NTM) revenue forecast is $9.5 billion.

Therefore, using a 33.8% FCF (i.e., the same as its LTM margin as of April 30):

   33.8% x $9.5b revenue = $3.2 billion FCF

In other words, FCF will stay strong. Moreover, using a 2.5% FCF yield valuation metric, its market cap could be worth $128 billion:

  $3.2b FCF / 0.025 = $128 billion market cap

That is +3.3% higher than today's market value of $123.9 billion. And using a 2.0% FCF yield metric, its value is 15% higher:

  $3.2b / 0.020 = $160 billion mkt cap forecast,

  $142.2 / $123.9b mkt cap today = 1.29 = +29% higher

On average, PANW could be worth +16% higher, or $215.95 per share (i.e., $186.08 x 1.16).

Analysts Agree PANW is Undervalued

This is similar to what other analysts think. For example, Yahoo! Finance reports that the average price target of 55 analysts is $212.01 per share.

Similarly, Barchart's mean survey price target is $212.36. AnaChart.com, which tracks recent analysts' price recommendations, shows that the average of 38 analysts is $204.37 per share.

The point is that, based on the company's strong FCF and FCF margins, as well as analysts' price targets, PANW looks undervalued here.

However, there is no guarantee that PANW will rise right away. One way to set a lower buy-in target and get paid while waiting, is to short out-of-the-money (OTM) put options and nearby expiry periods.

Shorting OTM Puts

For example, look at the June 20 expiration period, 28 days from now. It shows that the $177.50 strike price put option has a midpoint premium of $2.59 per put contract.

That means a short-seller of these puts makes an immediate yield of about 1.50% (i.e., $2.59/$177.50 = 0.1459) over the next month.

In other words, in return for a commitment to buy the stock at a price a little less than 5% below today's price, the short-seller can make a 1.5% monthly yield. The delta ratio shows there is only about a 25% chance that PANW will fall to this strike price in the next month.

An investor can set a lower price target and make a good expected return (ER) annually of 18.86% on a compounded basis (assuming this yield can be repeated and compounded each month for 12 months).

The bottom line is that PANW stock looks cheap here, and shorting OTM puts is one way to play this.

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.