Price-to-Cash Flow (P/CF) Ratio
What Is the Price-to-Cash Flow (P/CF) Ratio?
The price-to-cash flow (P/CF) ratio is a stock valuation indicator or multiple that measures the value of a stock's price relative to its operating cash flow per share. The ratio uses operating cash flow (OCF), which adds back non-cash expenses, for example, depreciation and amortization to net income.
P/CF is especially useful for esteeming stocks that have positive cash flow yet are not profitable because of large non-cash charges.
The Formula at the Cost to-Cash Flow (P/CF) Ratio Is
Instructions to Calculate the Price-to-Cash Flow (P/CF) Ratio
To keep away from volatility in the multiple, a 30-or 60-day average price can be utilized to get a more stable stock value that isn't skewed by random market movements.
The operating cash flow (OCF) used in the denominator of the ratio is obtained through a calculation of the trailing 12-month (TTM) OCFs generated by the firm divided by the number of shares outstanding.
As well as figuring it out on a per-share basis, the calculation should likewise be possible on a whole-company basis by isolating a company's total market value by its total OCF.
What Does the Price-to-Cash Flow (P/CF) Ratio Tell You?
The P/CF ratio measures how much cash a company generates relative to its stock price, rather than what it records in earnings relative to its stock price, as measured by the price-earnings (P/E) ratio.
The P/CF ratio is supposed to be a better investment valuation indicator than the P/E ratio because cash flows can't be manipulated as easily as earnings, which are affected by accounting treatment for items, for example, depreciation and other non-cash charges. Some companies might appear unprofitable because of large non-cash expenses, for example, even however they have positive cash flows.
Example of the Price-to-Cash Flow (P/CF) Ratio
Consider a company with a share price of $10 and 100 million shares outstanding. The company has an OCF of $200 million in a given year. Its OCF per share is as follows:
The company consequently has a P/CF ratio of 5 or 5x ($10 share price/OCF per share of $2). This means that the company's investors will pay $5 for every dollar of cash flow, or that the association's market value covers its OCF five times.
Alternatively, one can calculate the P/CF ratio on a whole-company level by taking the ratio of the company's market capitalization to its OCF. The market capitalization is $10 x 100 million shares = $1,000 million, so the ratio can likewise be calculated as $1,000 million/$200 million = 5.0, which is the same result as computing the ratio on a per-share basis.
Special Considerations
The optimal level of this ratio depends on the sector in which a company operates and its stage of maturity. A new and rapidly developing technology company, for instance, may trade at a lot higher ratio than a utility that has been in business for quite a long time.
This is because, albeit the technology company may just be possibly profitable, investors will actually want to give it a higher valuation because of its growth prospects. The utility, then again, has stable cash flows yet few growth prospects and, as a result, trades at a lower valuation.
There is no single figure that points to an optimal P/CF ratio. However, generally speaking, a ratio in the low single digits might indicate the stock is undervalued, while a higher ratio might suggest potential overvaluation.
The P/CF Ratio versus the Price-to-Free-Cash Flow Ratio
The price-to-free-cash flow ratio is a more thorough measure than the P/CF ratio.
However very like P/CF, this metric is considered a more exact measure because it uses free cash flow (FCF), which deducts capital expenditures (CapEx) from a company's total OCF, thereby reflecting the genuine cash flow available to fund non-asset-related growth. Companies use this metric when they need to expand their asset bases either to develop their businesses or simply to keep up with acceptable levels of FCF.
Features
- The P/CF multiple functions admirably for companies that have large non-cash expenses like depreciation.
- Some analysts prefer P/CF over price-to-earnings (P/E) since earnings can be more easily manipulated than cash flows.
- A low P/CF multiple may imply that a stock is undervalued in the market.
- The price-to-cash flow (P/CF) ratio is a multiple that compares a company's market value to its operating cash flow or its stock price per share to operating cash flow per share.
