What Does Cash Flow to Capital Expenditures Mean?
Cash flow to capital expenditures -- CF/CapEX -- is a ratio that measures a company's ability to acquire long-term assets using free cash flow. The CF/CapEX ratio will often fluctuate as businesses go through cycles of large and small capital expenditures. A higher CF/CapEX ratio is indicative of a company with sufficient capital to fund operations.
CF to CAPEX is calculated as:
Cash Flow to Capital Expenditures = Cash Flow from Operations / Capital Expenditures
Fundamental analysts seek to use real data to find clues and insights about a company. They believe the market is full of potentially undervalued or overvalued securities waiting to be bought or sold for a profit. The primary tool of fundamental analysis is the ratio. The cash flow to capital expenditures (CF/CapEX) ratio, like other ratios, provides information about company performance. Specifically, the ratio tells analysts how much cash the company is investing in capital expenditures, such as property, plant, and equipment (PP&E). This is important for analysts who are looking for growth stocks.
The CF/CapEX ratio is calculated by dividing cash flow from operations by capital expenditures. Both of these line items can be found on the cash flow statement. Capital expenditures are a line item in cash flow from investing because it is considered to be an investment in future years. For example, if a company has $10,000 in cash flows from operations and spends $5,000 on capital expenditures, it means that half of every dollar made from operations is going toward capital investment. If the company spends $1,000 on capital expenditures, it reduces the ratio to 10 to 1, meaning that only 10% of every dollar made from operations is going toward capital investment. If cash flows from operations are negative, capital expenditures are being funded by external sources.
In general, a high CF/CapEX ratio is a good sign and a low ratio is a bad one in terms of growth. Think of it like a car. All other things equal, regardless of the car, a car filled with gas is better than an empty car. Likewise, it is better to pay for gas out of the cash in your pocket than your credit card. The best-case scenario is a car that has recently been filled with gas that is paid for with cash in the driver's pocket. This is akin to a company with a high CF/CapEX ratio. Many analysts view capital expenditures as a driver of earnings growth, so a company with low investments in capital expenditures may not go as far as the company that just filled up on CapEX.