What is the 'PriceToCashFlow Ratio'
The pricetocashflow 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 noncash 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 noncash charges.
The pricetocashflow ratio is calculated as:
BREAKING DOWN 'PriceToCashFlow Ratio'
In order to avoid volatility in the multiple, a 30 or 60day 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 12month cash flows generated by the firm divided by the number of shares outstanding.
The pricetocashflow 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 priceearnings ratio. The pricetocashflow ratio is said to be a better investment valuation indicator than the priceearnings ratio, due to the fact that cash flows cannot be manipulated easily, as opposed to earnings, which are affected by depreciation and other noncash 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 pricetocashflow 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 pricetocashflow 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 pricetocashflow 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 pricetocashflow ratio, a ratio in the low single digits may indicate the stock is undervalued, while a higher ratio may suggest potential overvaluation.
The pricetofreecashflow ratio, which takes into account free cash flow (FCF) — or cash flow minus capital expenditures — is a more rigorous measure than the pricetocashflow ratio.

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