Amazon Inc. (AMZN) produced strong Q4 free cash flow (FCF) on February 6, despite much higher capex spending. Management expects this to continue, implying higher growth and FCF in the future. This could make AMZN stock a bargain.

AMZN stock is at $231.32 in midday trading on Tuesday, Feb. 11. That is off from its pre-earnings release peak of $242.06 on Feb. 4, but up from a trough of $197.22 on Nov. 22.

Nevertheless, AMZN stock could be 20% too cheap here with a target price of $277 per share. That makes it attractive to value investors. This is based on its strong FCF margins. This article will show why.

Moreover, this article will show how to use options to set a lower buy-on target price.

Strong FCF and FCF Margins

Amazon reported that its revenue rose 10% in Q4 and 11% YoY in 2024 to $638 billion. As a result, the company's free cash flow (FCF) rose 3.8% to $38.2 billion over the last year. 

Amazon is unique among tech companies in that it shows its rolling trailing 12-month (TTM) FCF figures:

Note that it provides several measures of FCF. The main point is that FCF has stayed positive despite much higher capex spending. For example, look at how the TTM figures fell from  Q3 to Q4. That was because capex spending was much higher.

Nevertheless, its $38.2 billion in TTM FCF in Q4 represented 5.99% of its $638 billion in TTM sales.

During the earnings call Andrew Jassy, President and CEO, indicated that its Q4 capex spending, mostly on AI and data centers, was $26.3 billion. That was up +16% from $22.62 billion in Q3, according to Seeking Alpha.

"…we spent $26.3 billion in capex in Q4. And I think that is reasonably representative of what you could expect in annualized capex rate in 2025. The vast majority of that capex spend is on AI for AWS."

He went on to say, according to the Motley Fool transcript, that this is good news for the company since:

“the faster we grow, the more capex we end up spending because we have to procure data center and hardware and chips and networking gear ahead of when we're able to monetize it. We don't procure it unless we see significant signals of demand.”

That implies that its heavy $104 billion in capex spending over the next year could imply much higher revenues. That is up significantly from $77.658 billion it spent in 2024 (+33.9%)

Let's see if we can estimate how that will work out.

Forecasting FCF

Analysts now project that sales this year will rise 9.5% to $698.6 billion, up from $638 billion. And next year it is expected to reach $771.1 billion, or +20.85%.

That implies, on average, over the next 12 months (NTM) Amazon is on a run-rate revenue of about $735 billion.

Moreover, in Q4 its TTM operating margin (i.e., cash flow from operations/revenue, before capex spending) was $115.877 billion, or 18.2% of sales of $638 billion.

Therefore, we can estimate that its NTM operating cash flow will be:

   $735 billion NTM revenue x 0.182 = $133.77 billion cash flow from operations

So, even after deducting $104 billion in capex spend, Amazon should still produce at least $30 billion in FCF:

  $133.77 - $104 capex = $29.77 billion FCF

Moreover, its highly likely that this higher demand could bring in higher operating margins. That is what operating leverage is all about. So, with just a small 10% increase in margin to a 20% OCF margin, its FCF will grow exponentially:

  $735 b x 0.20 OCF margin = $147 billion - $104b capex = $43 billion FCF = +11.4% higher than 2024 ($38.6 billion). That represents 5.85% of its $735 billion in NTM sales.

Moreover, a 12.1% increase to 22% OCF margins leads to a $57.7 billion FCF. That represents a 7.8% FCF margin.

So, you can see that this implies that Amazon's value could increase dramatically as a result of its higher capex spending.

Target Price for AMZN stock

One way that the market values fast-growing high-tech companies like Amazon is to use an FCF yield metric. This assumes that the company eventually pays out 100% of its FCF in both dividends and buybacks, much like Apple (AAPL) is doing now.  I discussed this in my recent article on AAPL on Feb. 2 ("Apple Stock Is Off Its Recent Highs, But Is It Poised to Rise Again?")

So, for example, given Amazon stock's market cap today of $2,451 trillion, its LTM FCF of $38.2 billion represents a yield of 1.558% (i.e., $38.2b /$ 2,451b) if it were to paid out 100% to shareholders.

So, let's use that to estimate AMZN stock's value given its forecast of between $43 billion and $57.7 billion in FCF over the next 12 months:

  $43b / 0.01558 = $2,760 billion, i.e., +12.6% over $2,451 billion mkt cap

  57.7b / 0.01558 = 3,703 billion, i.e., +51% higher

That implies that AMZN stock could be worth somewhere between 12.6% and 51% higher over the next 12 months, or +31.8% on average. This depends on how strong its FCF margins come in. To be conservative let's estimate that it will be worth at least +20% more:

  $231.32 x 1.20 = $277.59 or roughly $278 per share

The bottom line is that its target price is well over today's price, at least 12.6% more, and mostly likely at least 20% more.  

Analysts surveyed by AnaChart.com agree. Their average price target from 46 analysts is $273.77 per share. That is close to my estimate of $278 per share.

Two ways to play this are (1) to sell short out-of-the-money (OTM) put options in nearby expiry periods, and (2) buy in-the-money (ITM) long-dated periods, in order to set a lower buy-in entry price.

Using Options Set a Buy-In Entry Price

For example, look at the March 7 expiration period, 24 days to expiry (DTE). This shows that a short-seller can make an immediate 0.868% yield over three weeks (i.e., $1.91/$220).

That is because the midprice premium received is $191 for an investor who secures $22,000 in cash or buying power with their brokerage firm (i.e., $191/$22K = 0.868%).

The point is that the investor would be happy to spend $220 to buy 100 shares in AMZN, i.e., a price almost 5% below today's price. Moreover, their breakeven price would be even lower, since $220-$1.91 = $218.09, or 6% below today's trading price.

For investors who don't want to spend $22K to do this trade and are willing to take on more risk, it may make sense to buy in-the-money (ITM) call options over one year away. For example, the $220 call option for the March 20, 2026, expiration period trades for $41.65. 

That means an investor only has to spend $4,165 to buy one call option that already has some intrinsic value (i.e., it's in-the-money).

This can be seen in the table above. It shows that the ITM premium is $41.65 for a $220.00 strike price. That means the investor hopes to see the stock rise over $261.65 (i.e., $220 +41.65) in the next year. Since the stock is already at $232.16, it has $12.16 of intrinsic value:

  $232.16- $220.00 = $12.16 intrinsic value. 

That represents 29% of the $41.65 price paid for this call option. However, given that we estimate AMZN is worth $278 per share, if that happens, this call option would be worth:

   $278 - $220 = $58, or +39.2% more than the $41.65 paid

That is almost twice the 20% gain we expect in our target price mentioned above. Of course, if AMZN falls to $220 or lower, this call will expire worthless, so there is much more risk.

But consider this. The investor who sells short OTM puts for $1.91 each month could help pay for this $41.65 premium. Over 12 months that would cover $22.92 or 55% of the long-term call option price.

The bottom line here is that AMZN looks cheap to value investors. Two ways to play this are to sell short OTM puts in nearby expiry periods, as well as to buy ITM calls in long-term 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.