Price to Cash Flow Ratio

What Is the Price-to-Cash Flow Ratio – P/CF?

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
which adds back non-cash expenses 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 non-cash charges.

The Formula for the Price-to-Cash Flow Ratio – P/CF Is

Price to Cash Flow Ratio=

Operating Cash Flow per Share

Share Price

What Is the Price-To-Cash-Flow Ratio?

How to Calculate the Price-to-Cash Flow 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 used in the denominator of the ratio is obtained through a calculation of the
trailing 12-month operating cash flows generated by the firm divided 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 operating cash flow.

What Does the Price-to-Cash Flow Ratio Tell You?

The price-to-cash flow 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 ratio. The price-to-cash flow ratio is said to be a better investment valuation indicator than
the price-earnings ratio, due to the fact that cash flows cannot be manipulated as easily as earnings,
which are affected by depreciation and other non-cash items. Some companies appear unprofitable
because of large, non-cash expenses even though they have positive cash flows.

KEY TAKEAWAYS

The price-to-cash flow 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 price-to-cash flow multiple works well for companies that have large non-cash expenses such as
depreciation.

A low multiple implies that a stock may be undervalued.

Example of the Price-to-Cash Flow Ratio in Use

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 operating cash flow per share is as follows:

The company thus has a price-to-cash flow ratio of its share price of $10 / operating cash flow per
share of $2 = 5 or 5x. 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 operating cash flow five times.

Alternatively, calculate the price-to-cash flow ratio on a whole-company level, by taking the ratio of
the company’s market capitalization to its operating cash flow. 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, or the same result as calculating the ratio on a per-share basis.

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 price-to-cash flow ratio, a ratio in the low
single digits may indicate the stock is undervalued, while a higher ratio may suggest potential
overvaluation.