What Is the Price-to-Cash Flow (P/CF) Ratio?
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 (OCF), which adds back non-cash expenses such as depreciation and amortizationto 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.
Key Takeaways
- 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 P/CF 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.
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The Formula for the Price-to-Cash Flow (P/CF) RatioIs
PricetoCashFlowRatio=OperatingCashFlowperShareSharePrice
How to Calculate the Price-to-Cash Flow (P/CF) 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 (OCF) used in the denominator of the ratiois obtained through a calculation of the trailing 12-month (TTM) OCFs generated by the firmdivided 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 OCF.
What Does thePrice-to-Cash Flow (P/CF) Ratio Tell You?
The P/CF 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 P/CF ratio is said to be a better investment valuation indicator than the P/E ratio because cash flows cannot be manipulated as easily as earnings, which are affected by accounting treatment for items such as 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 (P/CF) Ratio
Consider a company with a share price of $10 and 100 million shares outstanding. The company has anOCFof $200 million in a given year. Its OCF per share is as follows:
100MillionShares$200Million=$2
The company thus has a P/CF ratio of 5 or 5x ($10 share price / OCF per share of $2). 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 OCF five times.
Alternatively, one can calculate the P/CF ratio on a whole-company level by taking the ratio of the company’s market capitalization to its OCF. The market capitalization is $10 x 100 million shares = $1,000 million, so the ratio can also be calculated as$1,000 million / $200 million = 5.0, which is the same result as calculating the ratio on a per-share basis.
Special Considerations
The optimal level of this ratio depends on the sector in which a company operatesand 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 prospectsand, as a result, trades at a lower valuation.
There is no single figure that points to an optimal P/CF ratio. However, generally speaking, a ratio in the low single digits may indicate the stock is undervalued, while a higher ratio may suggest potential overvaluation.
The P/CF Ratio vs. the Price-to-Free-Cash Flow Ratio
The price-to-free-cash flow ratio is a more rigorous measure than the P/CF ratio.
Though very similar to P/CF, this metric is considered a more exact measure because it uses free cash flow (FCF), which subtracts capital expenditures (CapEx) from a company's total OCF, thereby reflecting the actual cash flow available to fund non-asset-related growth. Companies use this metric when they need to expand theirasset baseseither to grow their businesses or simply to maintain acceptable levels of FCF.
