Price multiples are commonly used to determine the equity value of a company. The relative ease and simplicity of these relative valuation methods makes them among the favorites of institutional and retail investors. Price-to-earnings, price-to-sales and price-to-book values are typically analyzed when comparing the prices of various stocks based on a desired valuation standard. The price-to-cash-flow (P/CF) multiple falls into the same category as the above price metrics, as it evaluates the price of a company's stock relative to how much cash flow the firm is generating. (See also: Ratio Analysis.)

## Calculating the P/CF Ratio

P/CF multiples are calculated with a similar approach to what is used in the other price-based metrics. The P, or price, is simply the current share price. In order to avoid volatility in the multiple, a 30- or 60-day average price can be utilized to obtain a more stable value that is not skewed by random market movements. The CF, or cash flow, found in the denominator of the ratio, is obtained through a calculation of the trailing 12-month cash flows generated by the firm, divided by the number of shares outstanding.

Let's assume that the average 30-day stock price of company ABC is \$20—within the last 12 months \$1 million of cash flow was generated and the firm has 200,000 shares outstanding. Calculating the cash flow per share, a value of \$5 is obtained (\$1,000,000/200,000). Following that, one would divide \$20 by \$5 to obtain the required price multiple. Also note that the same result would be determined if the market cap is divided by the total cash flow of the firm. The P/E ratio is a simple tool for evaluating a company, but no single ratio can tell the whole story. (See also: Beware False Signals From The P/E Ratio.)

## Different Types of Cash Flow

Several approaches exist to calculate cash flow. When performing a comparative analysis between the relative values of similar firms, a consistent valuation approach must be applied across the entire valuation process. For example, one analyst might calculate cash flow as simply adding back non-cash expenses such as depreciation and amortization to net income, while another analyst may look at the more comprehensive free cash flow figure. Furthermore, an alternative approach to determining cash flow would be to simply sum the operating, financing and investing cash flows found within the cash flow statement.

While the free cash flow approach is the most time intensive, it typically produces the most accurate results, which can be compared between companies. Free cash flows are calculated as follows:

FCF = [Earnings Before Interest Tax * (1 – Tax Rate) + Depreciation + Amortization – Change in Net Working Capital – Capital Expenditures]

Most of these inputs can be quickly pulled (sometimes with some minor calculations) out of the firm's financial statements. Regardless of the approach implemented, it must be consistent. When trying to evaluate a company, it always comes down to determining the value of the free cash flows and discounting them to today. (See also: Valuing Firms Using Present Value Of Free Cash Flows.)

## Relative Value Analysis

Once the P/CF ratio is calculated, the initial result does not actually reveal anything of great significance to the analyst. Similar to the subsequent procedure for relative value methodologies—which use the P/E, P/S and P/BV multiples—the calculated P/CF must be assessed based on comparable companies. A P/CF of 5 does not actually reveal much useful information unless the industry and stage of life for the firm is known. A low free-cash-flow price multiple may be unattractive for an established slow-growth insurance firm yet present a solid buying opportunity for a small biotech startup. Basically, to get a sense if a company is trading at a cheap price relative to its cash flows, a list of appropriate comparables must form the comparison benchmark.