The price-to-cash flow ( cF) ratio is a pivotal stock valuation indicator that measures a stock’s price relative to its operating cash flow per share. This ratio employs operating cash flow (OCF), which incorporates non-cash expenses such as depreciation and amortization into net income.
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Key Takeaways
- What is P/CF? It compares a company’s market value to its operating cash flow or stock price per share.
- Spotlight on Non-Cash Expenses: Ideal for companies with substantial non-cash charges like depreciation.
- Valuation Indicator: A low P/CF ratio may signal that a stock is undervalued.
- Why P/CF? Analysts often favor P/CF over price-to-earnings (P/E) due to lesser manipulation of cash flows compared to earnings.
The Formula for the Price-to-Cash Flow (P/CF) Ratio
The formula is straightforward:
Price-to-Cash Flow Ratio = Share Price / Operating Cash Flow per Share
How to Calculate the Price-to-Cash Flow (P/CF) Ratio
To minimize volatility in the ratio, employing a 30- or 60-day average stock price can offer a more consistent value, unaffected by sudden market fluctuations.
The operating cash flow (OCF) used in the denominator is derived from the trailing 12-month (TTM) OCFs produced by the company, divided by the number of shares outstanding.
Calculating on a per-share basis is standard, but one can also assess the entire company by dividing its total market value by its total OCF.
What Does the Price-to-Cash Flow (P/CF) Ratio Tell You?
Unlike the price-earnings (P/E) ratio, the P/CF ratio focuses on the cash a company generates, minimizing manipulation usually seen with earnings influenced by non-cash charges. Hence, even if a company seems unprofitable due to large non-cash expenses, it could still boast 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, generating an OCF of $200 million annually. The OCF per share calculation is:
$200 Million / 100 Million Shares = $2
This results in a P/CF ratio of 5, meaning investors pay $5 for every dollar of cash flow.
Alternatively, calculating at the whole-company level using its market capitalization provides the same 5.0 ratio:
Market Capitalization ($1 billion) / OCF ($200 million) = 5.0
Special Considerations
The optimal P/CF ratio varies by sector and company maturity. Rapidly growing tech companies might command higher ratios than established utilities with stable but low-growth cash flows. Generally, a lower ratio suggests undervaluation, while a higher one might indicate overvaluation.
The P/CF Ratio vs. the Price-to-Free-Cash Flow Ratio
Price-to-free-cash flow (P/CF) ratio applies a stricter valuation by using free cash flow (FCF), which accounts for capital expenditures (CapEx). This metric better reflects the cash available for business growth or asset maintenance, making it a more stringent and insightful measure for investors.
Related Terms: price-to-earnings ratio, operating cash flow, price-to-free-cash flow ratio.
