Price to Cash Flow Ratio
The price to cash flow ratio (P/CF) is a stock valuation metric for a company’s stock price value with respect to its per-share operating cash flow. This number is partly dependent on operating cash flow. This is where non-cash expenses, such as asset write-downs and deferred income taxes, are re-added to net income.
It is particularly helpful for valuing stocks with positive cash flow but which are non-revenue earning due to considerable non-cash charges.
Analysts should also be cautious with certain cash flow numbers. Ensure these are used consistently when conducting a peer analysis. Operating cash flow and free cash flow are the two most widely used ratios. A good understanding of how each company reports such ratios is essential. And so is performing a nuts-and-bolts analysis.
Moreover, analysts must see to it that management is not manipulating figures just to increase the company’s short-term cash position. This is especially true if they stand to benefit from such numbers, such as by getting rewards or incentives.
Price to Cash Flow Ratio Formula
The price to cash flow ratio is a pretty straightforward calculation. The current share price is simply divided by the per-share operating cash flow, which is found in the cash flow statement.
To calculate operating cash flow you can use the formula below:
Sometimes, a modified price to cash flow ratio calculation is preferred, where free cash flow is used rather than total operating cash flow. Free cash flow allows adjustments for costs like capital expenditures, amortization and depreciation, etc.
To avoid risk, the average price within a 30 to 60-day period can be used to generate a more solid stock value that is unaffected by random market activities. To obtain the operating cash flow value, the firm’s trailing cash flow for a period of 12 months is divided by the company’s number of shares outstanding.
Aside from calculating on a per-share basis, the ratio can also be calculated for the entire firm. You would divide the company’s total market value by its cash flow from operations:
What makes a good price to cash flow ratio depends on the company’s stability and its industry. For example, a new and rapidly expanding tech firm may have a higher ratio compared to a utility company that has been around for half a century. The reason is, that while the tech firm company isn’t making so much profit at this point, investors are happy to give it a higher valuation owing to its promise of growth.
On the other hand, the utility company may have consistent cash flows. But because of its limited growth prospects, it will trade much lower. Even as there is not one number considered a good price to cash flow ratio, anything low and single-digit may be a sign of an undervalued stock, while a higher ratio may hint at the exact opposite scenario.
Price to Cash Flow Ratio Example
Assume EV Company, a metal fabricator, has an operating cash flow of $300 million within a year, a per-share price of $15, and 100 million shares outstanding. Based on the given values, the company’s Operating Cash Flow Per Share is calculated at $3. What is EV Company’s price to cash flow ratio?
Let’s break it down to identify the meaning and value of the different variables in this problem.
- Share price: $15
- Operating cash flow per share: $3
We can apply the values to our variables and calculate the price to cash flow ratio:
In this case, the company would have a price to cash flow ratio of 5.
This shows that investors of the company are happy making a $5 payment for each dollar of cash flow, or that the company’s market value is five times its cash flow from operations.
As an alternative, the price to cash flow ratio can be calculated for the entire company, by using the company’s market capitalization ratio against its operating cash flow.
With a share price of $15 and 100 million shares outstanding, market capitalization is equal to $1.5 billion. That means the ratio can be obtained by dividing $1.5 billion by $300 million, which still yields a per-share basis ratio of 5:
Price to Cash Flow Ratio Analysis
The price to cash ratio is among the most widely used metrics in the world of investments. Analysts usually have to determine a company’s valuation relative to how much cash it earns from underlying operations. Analyzing cash flows in relation to price is also good for comparing different companies that operate within the same industry.
Consider two metal fabrication companies with different price to cash flow ratios. The one with a higher number is more expensive than the other. But even so, an analyst should examine the situation from a general business perspective. It could be that the metal fabricator with the higher ratio had weak cash flows. Its share price just remained uncorrected.
Conversely, investors may be willing to pay more for it if, say, it is among the globe’s biggest metal fabricators and a strong turnaround in the company is in order. Again, when there is baseless hype concerning a certain company, it is best to avoid it. Valuation also relies on investors’ perception and risk tolerance.
Of course, analysts must always compare market expectations to ratios, as well as look into the forces behind these numbers. A detailed financial analysis must be performed to know whether or not management is exploring creative avenues for the improvement of short-term cash flows at the cost of long-term value.
The price to cash flow ratio is a good tool for valuing companies with positive cash flow but negative cash earnings, but not when a company is not making any positive cash flows. The ratio should be examined side by side with other valuation ratios like price to earnings and price to sales. Or, compare it with absolute valuation metrics such as discounted cash flow. This determines a company’s absolute value according to future expectations.
Price to Cash Flow Ratio Conclusion
- The price to cash flow ratio compares a company’s market value against its cash flow from operations.
- This formula requires two variables: share price and operating cash flow per share.
- The price to cash flow ratio is usually expressed as a plain decimal number.
- This calculation is best used by companies with considerable non-cash expenses (for example, amortization).
- a low price to cash flow ratio is a sign of an undervalued stock.
Price to Cash Flow Ratio Calculator
You can use the price to cash flow ratio calculator below to quickly measure a company’s stock price value relative to its per-share operating cash flow by entering the required numbers.
1. What is the price to cash flow ratio?
The price to cash flow ratio (P/CF) is a stock valuation metric for a company’s stock price value with respect to its per-share operating cash flow.
2. How is the price to cash flow ratio calculated?
The price to cash flow ratio is calculated by using the following formula:
P/CF = Price per Share / Operating Cash Flow per Share
3. When is the price to cash flow ratio most useful?
The price to cash flow ratio is most useful when companies have negative earnings but positive operating cash flows. In this case, the P/CF ratio will be more indicative of a company’s value than its P/E ratio.
4. What is a good price to cash flow ratio?
A good price to cash flow ratio is anything below 10. The lower the number, the better the value of the stock. This is because a lower ratio indicates that the company is undervalued with respect to its cash flows.
Conversely, a high price to cash flow ratio means the company is overvalued with respect to its cash flows.
5. What is an example calculation of the price to cash flow ratio?
An example calculation of the price to cash flow ratio would be as follows:
Let's say a company's share price is $100 and its operating cash flow per share is $10.
The P/CF ratio would be calculated as follows:
P/CF = 100 / 10 = 10