The price-to-cash-flow (P/CF) ratio, which measures a stock's value in relation to its operating cash flow per share, is a stock valuation indicator or multiple. The operating cash flow (OCF) ratio is used to account for non-cash expenses like depreciation and amortization, which boost net income.
P/CF is particularly helpful for appraising firms with good cash flow but negative profitability due to significant non-cash charges.
Formula for the Price-to-Cash Flow (P/CF) Ratio
Price to Cash Flow Ratio = Share Price / Operating Cash Flow per Share
How to Determine the Price-to-Cash Flow Ratio (P/CF)
A 30- or 60-day average price can be used to get a more stable stock value that is not distorted by erratic market movements, hence reducing volatility in the multiple.
The operating cash flow (OCF) utilized in the ratio's denominator is calculated by dividing the firm's trailing 12-month (TTM) OCFs by the total number of outstanding shares.
By dividing a firm's whole market value by its total OCF, the computation can also be done on a whole-company basis in addition to on a per-share one.
What Can You Infer from the Price-to-Cash Flow (P/CF) Ratio?
Instead of looking at how much money a firm makes in relation to the price of its stock, as determined by the price-earnings (P/E) ratio, the P/CF ratio examines how much cash it generates.
Because cash flows cannot be easily manipulated, unlike earnings, which are impacted by the accounting treatment of things like depreciation and other non-cash costs, the P/CF ratio is thought to be a stronger predictor of investment pricing than the P/E ratio. Even while some businesses have positive cash flow, they may nonetheless appear unprofitable due to significant non-monetary expenses, for instance.
Example of the Price-to-Cash Flow (P/CF) Ratio
Think about a business with 100 million shares outstanding and a share price of $10. The business has a $200 million OCF each year. This is its OCF per share:
To calculate the value per share, divide the total value of $200 million by the number of outstanding shares, which is 100 million. This results in a value of $2 per share.
The P/CF ratio of the company is 5 or 5x, which is derived by dividing the share price of $10 by the OCF per share of $2. This implies that the investors of the firm are ready to pay $5 for each dollar of cash flow or that the market capitalization of the company is five times higher than its OCF.
As an alternative, one can determine the P/CF ratio for the entire firm by dividing the market capitalization by the operating cash flow. The ratio can alternatively be computed as $1,000 million / $200 million = 5.0, which yields the same result as calculating the ratio on a per-share basis: the market capitalization is $10 x 100 million shares, or $1,000 million.
The ideal value of this ratio depends on the industry and stage of development in which a company operates. For instance, a young and fast expanding technological company may trade at a significantly greater ratio than a utility that has been there for a long time.
This is due to the fact that investors will be ready to offer the technological business a higher valuation due to its growth prospects, even though it may only be moderately profitable. The utility, on the other hand, trades at a lower valuation due to its predictable cash flows but limited growth prospects.
There isn't a single definitive number that characterizes an ideal P/CF ratio. However, a ratio that is in the low single digits often indicates that the company is undervalued, while a higher ratio may suggest that the company is overvalued.