DocuSign, Inc. (DOCU) reported that it generated solid results in Q2 last week. This included a 7.8% higher free cash flow YoY based on its consistent subscription revenue. As a result, DOCU stock could be worth up to 40% more at $80 per share.

In Monday midday trading on Sept. 9, DOCU is trading at $56.75, down 4.1% from its peak on Friday at $59.19. Value investors are looking at the stock closely given how strong its results were last week.

Revenue rose 7% YoY to $736 million for the quarter, and half-year sales were up 7.1% as well. Moreover, subscriptions represented over 97.4% of quarterly sales, so its cash flow remained strong. 

For example, free cash flow (FCF) rose 7.8% to $197.8 million, and half-year FCF was up 8.0% to $430 million. Moreover, the FCF margins (i.e., FCF/sales) remained strong, albeit lower in the latest quarter. For example, FCF represented 26.9% of its $736 million in Q2 revenue, but 32.9% of the $1,309 million in half-year sales.

As a result, DOCU stock looks undervalued here. Here's why.

Valuing DOCU Stock Using FCF

In its quarterly report, DocuSign management raised its revenue projections for both Q3 and for the year ending Jan. 31, 2025. As a result, analysts now expect revenue to reach $2.95 billion this year and $3.12 billion next year, based on Seeking Alpha's survey of 20 analysts.

Therefore, assuming FCF stays strong at a minimum 27% margin for all of next year, free cash flow could reach $842.4 million (i.e., 0.27 x $3.12b). 

Moreover, its trailing 12-month (TTM) FCF was 32.1% (i.e., $919m FCF/$2,859 TTM sales) and the half-year FCF margin was 32.9%. As a result, it's likely that by 2025 the FCF margin will be at least 32%. That implies that FCF could be about $1 billion (i.e., 0.32 x $3.12b 2025 est. revenue = $998.4m).

This represents an. 8.6% higher FCF result over the last 12 months (i.e. $998.4/$919m-1 = +8.64%). Moreover, DOCU stock is likely to be valued higher by the market.

Target Price

For example, let's assume the market values this estimated free cash flow (FCF) using a 20x metric. That is also the same as using a 5.0% FCF yield valuation (i.e., 1/0.05 = 20x).

As a result, the stock's market cap could rise to $20 billion (i.e., $1b/0.05 = $20b). That represents a huge 66.7% gain over its present $12 billion market value today.

But, just to be conservative, let's assume that FCF is only $842.4 million (using the 27% FCF margin against 2025 revenue estimates). At 20x FCF that gives DocuSign a value of $16.84 billion. This is still 40.3% over today's $12 billion market cap.

In other words, DOCU stock is worth 40% more at $79.62 per share (i.e., 1.403 x $56.75). Analysts agree that DOCU stock is cheap here. For example, Barchart's survey shows a mean price of $63.57, and Yahoo! Finance reports that 16 analysts have an average price target of $64.31. In addition, AnaChart reports that 18 analysts who've written on the stock recently have an average price target of $75.35. That is close to my price target of $79.62.

One way to play this today is to sell short out-of-the-money (OTM) put options. That way the investor has a lower buy-in target price and gains income as well.

Shorting OTM Puts

For example, the Oct. 4 expiration period, 25 days from now, shows that the $53.00 strike price put, 6.59% below today's price, has a bid premium of 45 cents. That means that the short put investor for this put option can make an immediate 0.85% yield.

So, if an investor secures $5,300 with their brokerage firm, they can enter an order to “Sell to Open” 1 put contract at $53.00. The account will then immediately receive $45.00. That represents a yield of almost 1% (i.e., $45/$5,300 = 0.85%).

As long as DOCU stays over $53 for the next 25 days the investor's secured cash will not be used to buy 100 shares at $53.00. But even if that happens, the investor's breakeven price is $53.00-0.45 or $52.55 per share. That is 7.8% below today's price, providing good downside protection.

In other words, this is a good way to set a lower buy-in target price and to gain income along the way. Moreover, if this trade can be repeat once a month for three months, the investor can make an expected return (ER) of $135. That represents a quarterly ER yield of 2.55% over the next quarter.

The bottom line is that DOCU stock looks cheap here. This is based on DocuSign's consistent revenue, subscriptions, free cash flow, FCF margins, FCF yield valuation, and analysts' target prices.

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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.