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.
P/CF 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 (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 price-to-cash flow 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 Ratio Is
Price to Cash Flow Ratio=Operating Cash Flow per ShareShare Price
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 (P/E) ratio. The price-to-cash flow ratio is said to be a better investment valuation indicator than the price-earnings ratio because cash flows cannot be manipulated as easily as earnings, which are affected by accounting treatment for items like 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 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 = 5.0, 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.
Difference Between the P/CF Ratio and the Price-to-Free-Cash Flow Ratio
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. This metric is very similar to price to cash flow but is considered a more exact measure, since it uses free cash flow, which subtracts capital expenditures (CAPEX) from a company's total operating cash flow (CFO), 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 in order to grow their businesses or simply to maintain acceptable levels of free cash flow.