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International Business Machines Corp. (IBM) reported on Oct. 22 its highest adjusted free cash flow (FCF) margin (i.e., FCF/revenue) in its history at 15% for the year-to-date ending Sept. 30. Moreover, IBM raised its full-year outlook for FCF, which could push IBM stock at least 10% higher at $345.00 per share. IBM stock closed Monday, Oct. 27, at $313.09, up from a recent low of $275.97 on Oct. 16. (i.e., +13.5%). Improved FCF Outlook Investors are likely pleased that management raised its full-year 2025 adj. FCF outlook to $14 billion, up from its projection of $13.5 billion for 2025 in Q2. It makes a significant amount of its full-year FCF in Q4, as its YTD adj. FCF was only $7.181 billion, implying $6.189 billion (i.e., $14b - $7.181b YTD Q3) expected for Q4. Last year's Q4 adj. FCF was $6.163 billion. That implies a slight increase this Q4. It also implies a full-year 20.9% FCF margin, as analysts are projecting $67.02 billion in revenue for 2025 (i.e., $14.0b / $67.02 billion). Moreover, based on analysts' forecasts for 2026, its full-year FCF could rise even further. For example, assuming it makes a 21% adj. FCF margin next year, and using analysts' forecasts of $70 billion in revenue: 0.21 x $70 billion = $14.7 billion FCF for 2026 Target Price for IBM Stock FCF Yield Target Price. That could lead to a higher stock price, based on its historical FCF yield metric. For example, the trailing 12-month (TTM) adj. FCF has been 4.56% (i.e., $13.344 billion TTM / $292.656 billion market cap). So, if we assume that in 2026, with the adj. FCF estimate of $14.7 billion and the 4.56% FCF yield, the market cap could rise to $322.4 billion: $14.7 billion / 0.0456 = $322.4 billion That is 10.2% higher than today's market cap of $292.656 billion. In other words, IBM stock could rise over 10% over the next year to $345 per share: $313.09 x 1.102 = $345.00 Analysts Agree. Yahoo! Finance reports that 20 analysts have an average price target of $313.09. Moreover, AnaChart.com reports that 11 analysts have an average target of $345.69. That is close to my FCF yield-derived target price. The bottom line is that IBM stock looks cheap based on its strong FCF and analysts' target prices. One way to play IBM is to sell short out-of-the-money (OTM) put options for a lower buy-in price and to generate extra income. Shorting OTM Puts For example, the Nov. 28 options expiration period shows that the $300.00 strike price put option has a midpoint premium of $6.57. That means a short-seller of these puts can make an immediate yield of 2.19%: $6.57/$300.00 = 0.0219 = 2.19% one-month yield This shows that the strike price is 4% below Monday's price - i.e., it's out-of-the-money. But, even if IBM stock falls 4% to $300.00 and the short-seller's collateral of $30,000 per contract is assigned to buy 100 shares, the breakeven point is still lower: $300.00 - $6.57 = $293.43 breakeven $293.43 B/E / $313.09 trading price -1 = -6.23% downside protection The point is that by shorting the $300.00 put option, the investor has a potential buy-in 6.23% lower than the trading price today. In the meantime, the investor makes a 2.19% yield per month while waiting for this lower potential buy-in point. Moreover, even if that occurs, the upside is quite good: $345 target / $293.43 breakeven -1 = 0.1758 = +17.6% upside The bottom line is that IBM stock appears to be undervalued here, and one way to capitalize on this is to sell out-of-the-money puts.
