What Is the Price-to-Cash Flow Ratio – P/CF?
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 which adds back non-cash expenses such as depreciation and amortization to net income. It is especially useful for valuing stocks that have positive cash flow but are not profitable because of large non-cash charges.
The Formula for the Price-to-Cash Flow Ratio – P/CF Is
Price to Cash Flow Ratio=Operating Cash Flow per ShareShare Price
What Is the Price-To-Cash-Flow Ratio?
How to Calculate the Price-to-Cash Flow 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 used in the denominator of the ratio is obtained through a calculation of the trailing 12-month operating cash flows 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 operating cash flow.
What Does the Price-to-Cash Flow Ratio Tell You?
The price-to-cash flow 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 ratio. The price-to-cash flow ratio is said to be a better investment valuation indicator than the price-earnings ratio, due to the fact that cash flows cannot be manipulated as easily as earnings, which are affected by depreciation and other non-cash items. Some companies appear unprofitable because of large, non-cash expenses even though they have positive cash flows.
- The price-to-cash flow 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 price-to-cash flow multiple works well for companies that have large non-cash expenses such as depreciation.
- A low multiple implies that a stock may be undervalued.
Example of the Price-to-Cash Flow Ratio in Use
Consider a company with a share price of $10 and 100 million shares outstanding. The company has an operating cash flow of $200 million in a given year. Its operating cash flow per share is as follows:
100 Million Shares$200 Million=$2
The company thus has a price-to-cash flow ratio of its share price of $10 / operating cash flow per share of $2 = 5 or 5x. 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 operating cash flow five times.
Alternatively, calculate the price-to-cash flow ratio on a whole-company level, by taking the ratio of the company’s market capitalization to its operating cash flow. The market capitalization is $10 x 100 million shares = $1,000 million. It follows that the ratio can also be calculated as $1,000 million / $200 million = 5, or the same result as calculating the ratio on a per-share basis.
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.
Although there is no single figure that points to an optimal price-to-cash flow ratio, a ratio in the low single digits may indicate the stock is undervalued, while a higher ratio may suggest potential overvaluation.