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. Operating Cash Flow Ratio

    The operating cash flow ratio is a measure of how well current ...
  2. Accounting Ratio

    Accounting ratios, also known as financial ratios, are used to ...
  3. Free Cash Flow Yield

    Free cash flow yield is a financial ratio that standardizes the ...
  4. Operating Cash Flow Margin

    Operating cash flow margin measures cash from operating activities as ...
  5. Current Ratio

    The current ratio is a liquidity ratio that measures a company's ...
  6. Capitalization Ratios

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

    Analyze cash flow the easy way

    Learn the key components of the cash flow statement, how to analyze and interpret changes in cash, and what improved free cash flow means to shareholders.
  2. 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 ...
  3. 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. Learn how to read the cash flow statement.
RELATED FAQS
  1. How are cash flow and free cash flow different?

    Both cash flow and free cash flow are financial metrics that measure a company's liquidity, but one shows how effectively ... Read Answer >>
  2. Why do shareholders need financial statements?

    Discover the importance of a company's financial statements for stock shareholders in evaluating their equity investment ... Read Answer >>
  3. 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 >>
  4. How can EV/EBITDA be used in conjunction with the P/E ratio?

    Learn how traders and analysts use the two equity evaluation metrics, EV/EBITDA and P/E, together to obtain a more complete ... Read Answer >>
  5. How can cash flows be manipulated or distorted?

    Cash flows can be manipulated or distorted in many ways, including changing accounts payable, misusing non-operating cash, ... Read Answer >>
Trading Center