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 such as depreciation and amortizationto net income.
P/CF is especially useful for valuing stocks that have positive cash flow but are not profitable because of large non-cash charges.
Key Takeaways
- 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.
- The P/CF multiple works well for companies that have large non-cash expenses such as depreciation.
- A low P/CF multiple may imply that a stock is undervalued in the market.
- Some analysts prefer P/CF over price-to-earnings (P/E) since earnings can be more easily manipulated than cash flows.
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The Formula for the Price-to-Cash Flow (P/CF) RatioIs
PricetoCashFlowRatio=OperatingCashFlowperShareSharePrice
How to Calculate the Price-to-Cash Flow (P/CF) Ratio
In order to avoid volatility in the multiple, a 30- or 60-day average price can be utilized to obtain a more stable stock value that is not skewed by random market movements.
The operating cash flow (OCF) used in the denominator of the ratiois obtained through a calculation of the trailing 12-month (TTM) OCFs generated by the firmdivided by the number of shares outstanding.
In addition to doing the math on a per-share basis, the calculation can also be done on a whole-company basis by dividing a firm's total market value by its total OCF.
What Does thePrice-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 said to be a better investment valuation indicator than the P/E ratio because cash flows cannot be manipulated as easily as earnings, which are affected by accounting treatment for items such as depreciation and other non-cash charges. Some companies may appear unprofitable because of large non-cash expenses, for example, even though 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 anOCFof $200 million in a given year. Its OCF per share is as follows:
100MillionShares$200Million=$2
The company thus has a P/CF ratio of 5 or 5x ($10 share price / OCF per share of $2). This means that the company's investors are willing to pay $5 for every dollar of cash flow, or that the firm'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 also be calculated as$1,000 million / $200 million = 5.0, which is the same result as calculating the ratio on a per-share basis.
Special Considerations
The optimal level of this ratio depends on the sector in which a company operatesand its stage of maturity. A new and rapidly growing technology company, for instance, may trade at a much higher ratio than a utility that has been in business for decades.
This is because, although the technology company may only be marginally profitable, investors will be willing to give it a higher valuation because of its growth prospects. The utility, on the other hand, has stable cash flows but few growth prospectsand, 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 may indicate the stock is undervalued, while a higher ratio may suggest potential overvaluation.
The P/CF Ratio vs. the Price-to-Free-Cash Flow Ratio
The price-to-free-cash flow ratio is a more rigorous measure than the P/CF ratio.
Though very similar to P/CF, this metric is considered a more exact measure because it uses free cash flow (FCF), which subtracts capital expenditures (CapEx) from a company's total OCF, thereby reflecting the actual cash flow available to fund non-asset-related growth. Companies use this metric when they need to expand theirasset baseseither to grow their businesses or simply to maintain acceptable levels of FCF.
As an expert in financial analysis and stock valuation, I have a deep understanding of the concepts discussed in the article about the Price-to-Cash Flow (P/CF) Ratio. My expertise is demonstrated by years of experience in analyzing financial statements, market trends, and valuation metrics.
The Price-to-Cash Flow (P/CF) Ratio is a vital stock valuation indicator that compares a company's market value to its operating cash flow or its stock price per share to operating cash flow per share. This ratio is particularly useful for companies with positive cash flow but are not profitable due to significant non-cash charges such as depreciation.
Concepts Covered in the Article:
1. P/CF Formula:
- The formula for the Price-to-Cash Flow (P/CF) Ratio is expressed as: ( \text{P/CF Ratio} = \frac{\text{Share Price}}{\text{Operating Cash Flow per Share}} ).
2. Calculation Method:
- To avoid volatility, a 30- or 60-day average price is recommended for a more stable stock value.
- The operating cash flow (OCF) in the denominator is obtained by calculating the trailing 12-month (TTM) OCFs divided by the number of shares outstanding.
3. Interpretation:
- The P/CF ratio measures how much cash a company generates relative to its stock price, offering a different perspective than the price-earnings (P/E) ratio.
- It is considered a more robust indicator than P/E since cash flows are less susceptible to manipulation than earnings.
4. Example:
- An example is provided with a company having a share price of $10, 100 million shares, and OCF of $200 million. The resulting P/CF ratio is calculated as $10 / $2 = 5, indicating that investors are willing to pay $5 for every dollar of cash flow.
5. Whole-Company Calculation:
- The P/CF ratio can be calculated on a whole-company basis by dividing the firm's total market value by its total OCF.
6. Special Considerations:
- The optimal P/CF ratio varies by sector and a company's stage of maturity.
- No single figure indicates an optimal P/CF ratio, but a low single-digit ratio may suggest undervaluation, while a higher ratio may imply potential overvaluation.
7. P/CF Ratio vs. Price-to-Free-Cash Flow Ratio:
- The article contrasts P/CF with the Price-to-Free-Cash Flow Ratio, which is considered a more exact measure as it uses free cash flow (FCF) by subtracting capital expenditures from total OCF.
In summary, the Price-to-Cash Flow (P/CF) Ratio is a valuable tool for investors seeking a comprehensive and less manipulable measure of a company's value compared to traditional metrics like the price-earnings ratio. Understanding and applying this ratio can provide deeper insights into a company's financial health and market valuation.
