Today Amazon.com Inc. (AMZN) stock has unusual activity in a near-term call options strike price. This highlights the underlying value of AMZN stock after Amazon posted strong Q1 results yesterday.

AMZN stock is up over $3.00, or 1.8% today to $178.12 per share. The Barchart Unusual Stock Options Activity Report today shows that over 4,600 call option contracts have traded at the $205.00 strike price for the expiry period ending June 7, 2024, which is 37 days from now.

That volume of call options is unusual since it is almost 13 times the prior outstanding number of call contracts at that strike price. Moreover, the $205 strike price is 15% over today's price, indicating that the long buyers of those calls believe that the stock is undervalued.

It also shows that existing investors who sold short these calls are comfortable selling their shares at $205 if the stock rises to that level. The premium they received is 37 cents on the bid side and 54 cents in the midpoint. That means that the bid side covered call yield is 20.7 basis points (i.e., 0.207%) for a little over a month until expiration.

The bottom line is that this shows investors are cheerful about Amazon's near-term prospects.

Strong Q1 Results

This call option activity came after its results showed that revenue rose 13% Y/Y to $143.3 billion from $127.4 billion a year ago. Amazon also reported that its free cash flow (FCF) was positive $50 billion over the trailing 12 months (TTM), compared to negative $3.3 billion a year ago.

This was 35.9% higher than the $36.8 billion in FCF it made in 2023. That shows that the company's return to financial health is continuing strongly.

FCF Margins Could Lead to a Much Higher FCF

This is important since the Q1 FCF margin (i.e., FCF / sales) was higher than last quarter. For example, Amazon's TTM Q1 FCF margin in Q1 was 8.4% (i.e., $50b/$590.74 TTM sales). That was significantly higher than the 6.4% FCF margin in Q4 on a TTM basis (i.e., $36.8 billion / $574.8 billion sales in 2023).

In other words, its Q1 TTM FCF margin was 31% higher than last quarter. This shows that the company is on track to a very profitable year, in terms of free cash flow generation.

For example, analysts now project that sales in 2024 will rise to $637.91 billion (30 analysts surveyed by Seeking Alpha's “Earnings” page). And next year they project $712.97 billion in revenue. These forecasts are 11% and 24% higher than its 2023 revenue ($590.74 billion), implying that FCF could rise by at least this amount over the next 2 years.

However, operating leverage will push its FCF growth even higher. For example, assuming Amazon can average 10% FCF margins in 2024, its FCF could rise to $63.8 billion this year from $36.8 billion last year. That would be 73.3% higher, not just 11% higher as assumed from the revenue growth rate.

Moreover, by 2025, with a 10% FCF margin, its FCF could rise to $71.3 billion. That implies over the next 12 months (NTM) its run rate FCF would average $67.55 billion, or 83.6% higher than in 2023.

Price Targets for AMZN Stock

This operating leverage effect implies that AMZN stock could be worth at least 25% more than today. For example, let's assume that Amazon was to pay 100% of its FCF in dividends over the next 12 months. After all, both Alphabet (GOOG) and Meta Platforms (META) have recently decided to start paying dividends, so why wouldn't Amazon?

That might lead to at least a 0.46% dividend yield for AMZN stock. For example, GOOG stock has a 0.48% dividend yield now and META stock has a 0.46% yield. Both companies are paying out between 10% and 15% of their ongoing free cash flow estimates in dividends. 

That implies that Amazon's dividend, using a 15% payout ratio would be about $10 billion (i.e., 15% x $67.55 billion NTM FCF estimate). So if we apply a 0.46% dividend yield to this, i.e., divide $10 billion by 0.0046, the resulting market cap is $2.173 trillion. That is about 18.5% higher than AMZN stock's 1.844 trillion market cap today

That shows that AMZN stock is worth around $210 per share today (i.e. 18.5% over today's price of $178 per share). Moreover, 46 analysts surveyed by AnaChart, a new sell-side analyst tracking service, have an average price target of $214.33 per share, over 19% higher than yesterday's close.

The bottom line is that given the company's strong FCF margin performance today's unusual call option activity highlights the underlying value of AMZN stock.