Loading the player...

What is the 'Price-To-Cash-Flow Ratio'

The price-to-cash-flow ratio is a stock valuation indicator that measures the value of a stock’s price to its cash flow per share. The ratio takes into consideration a stock’s operating cash flow (OCF), which adds non-cash earnings 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 price-to-cash-flow ratio is calculated as:

Formula for Price-To-Cash-Flow Ratio

BREAKING DOWN '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 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.

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 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 easily, as opposed to earnings, which are affected by depreciation and other non-cash items.

For example, 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 cash flow per share is $200 million / 100 million shares = $2. The company, therefore, has a price-to-cash-flow ratio of share price of $10 / cash flow per share of $2 = 5. This means that the company's investors are willing to pay $5 for every dollar of cash flow.

An alternate way of calculating price-to-cash-flow ratio is by taking the ratio of a company’s market capitalization to its operating cash flow. From the above example, 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. Notice that this is the same figure we got when we calculated the price-to-cash-flow ratio.

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.

The price-to-free-cash-flow ratio, which takes into account free cash flow (FCF) — or cash flow minus capital expenditures — is a more rigorous measure than the price-to-cash-flow ratio.

RELATED TERMS
  1. Free Cash Flow Yield

    An overall return evaluation ratio of a stock, which standardizes ...
  2. Price to Free Cash Flow

    A valuation metric that compares a company's market price to ...
  3. Cash Flow-to-Debt Ratio

    The cash flow-to-debt ratio is a measure that compares a company’s ...
  4. Operating Cash Flow Margin

    Operating cash flow margin measures cash from operating activities as ...
  5. Operating Cash Flow - OCF

    Operating Cash Flow (or OCF) is a measure of the amount of cash ...
  6. Capitalization Ratios

    Capitalization ratios are indicators that measure the proportion ...
Related Articles
  1. Investing

    Financial Ratios to Spot Companies Headed for Bankruptcy

    Obtain information about specific financial ratios investors should monitor to get early warnings about companies potentially headed for bankruptcy.
  2. Investing

    Free cash flow yield: The best fundamental indicator

    Cash in the bank is what every company strives to achieve. Find out how to determine how much a company is generating and keeping.
  3. Investing

    5 Common Trading Multiples Used In Oil And Gas Valuation

    Before you decide to invest in oil and gas, you should understand these multiples.
  4. Investing

    Corporate cash flow: Understanding the essentials

    Tune out the accounting noise and see whether a company is generating the stuff it needs to sustain itself.
  5. Investing

    Sysco and Other Big Movers In Services

    The market has been slipping so far today. The Nasdaq has fallen 0.3%; the S&P 500 has fallen 0.4%; and the Dow has declined 0.5%. The Services sector (IYC) is currently lagging behind the overall ...
  6. Investing

    Analyzing General Electric's Debt Ratios in 2016 (GE)

    Evaluate GE's debt picture using the most important metrics for a large-cap conglomerate, including the debt-to-equity (D/E) ratio and the interest coverage ratio.
RELATED FAQS
  1. What does the operating cash flow ratio measure?

    Learn about the operating cash flow ratio, how the ratio is calculated and what it indicates about a company. Read Answer >>
  2. Are taxes calculated in operating cash flow?

    Learn how taxes are involved with the calculations for a firm's operating cash flow, and the overall significance of operational ... Read Answer >>
  3. What are some alternative liquidity ratios to the cash ratio?

    Learn what the cash ratio measures, and understand what two other liquidity ratios can be used by a company to replace the ... Read Answer >>
  4. What factors decrease cash flow from operating activities?

    Understand the types of factors that reduce cash flow from operation activities. Discover how declining net income and efficiency ... Read Answer >>
Hot Definitions
  1. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
  2. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing a company that measures its current share price relative ...
  3. Internal Rate of Return - IRR

    Internal Rate of Return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments.
  4. Limit Order

    An order placed with a brokerage to buy or sell a set number of shares at a specified price or better.
  5. Current Ratio

    The current ratio is a liquidity ratio that measures a company's ability to pay short-term and long-term obligations.
  6. Return on Investment (ROI)

    Return on Investment (ROI) is a performance measure used to evaluate the efficiency of an investment or compare the efficiency ...
Trading Center