Price-to-Cash Flow (P/CF) Ratio? Definition, Formula, and Example

Price-to-Cash Flow (P/CF) Ratio

Investopedia / Jiaqi Zhou

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 amortization to 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.

What Is the Price-To-Cash-Flow Ratio?

The Formula for the Price-to-Cash Flow (P/CF) Ratio Is

 Price to Cash Flow Ratio = Share Price Operating Cash Flow per Share \text{Price to Cash Flow Ratio}=\frac{\text{Share Price}}{\text{Operating Cash Flow per Share}} Price to Cash Flow Ratio=Operating Cash Flow per ShareShare Price

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 ratio is obtained through a calculation of the trailing 12-month (TTM) OCFs generated by the firm divided 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 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 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 an OCF of $200 million in a given year. Its OCF per share is as follows: 

$200 Million 100 Million Shares = $ 2 \frac{\text{\$200 Million}}{\text{100 Million Shares}} = \$2 100 Million Shares$200 Million=$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 operates and 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 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 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 their asset bases either to grow their businesses or simply to maintain acceptable levels of FCF.