What is the Price-to-Cash Flow Ratio?
The price-to-cash flow (also denoted as price/cash flow or P/CF) ratio is a financial multiple that compares a company’s market value to its operating cash flow (or the company’s stock price per share to its operating cash flow per share).
Essentially, the price-to-cash flow ratio measures the current price of the company’s stock relative to the amount of cash generated by the company. The price-to-cash flow multiple is primarily used in the comparable analysis method of stock valuation.
Formula for the Price-to-Cash Flow Ratio
From the definition, the price-to-cash flow ratio involves two methods of calculation. Firstly, the multiple can be calculated using the company’s market capitalization. In such a case, the price-to-cash flow formula is the following:
Also, the price-to-cash flow ratio can be calculated on a per share basis. The price-to-cash flow ratio formula on per share basis is:
Applications of the Price-to-Cash Flow Ratio
Similar to other multiples used in stock valuation, the application of the price-to-cash flow ratio is suitable only in certain cases. For example, the use of the operating cash flow in the P/CF ratio makes the ratio a perfect choice to value the stocks of companies with large non-cash expenses (e.g., depreciation). In certain scenarios, companies with positive cash flows are not profitable due to their large non-cash expenses. The P/CF ratio allows analysts and investors to come up with a less distorted picture of a company’s financial standing.
Although there is no consensus regarding the optimal levels for the P/CF ratio, it is commonly accepted that a low multiple indicates that a stock is undervalued. High P/CF ratios are common for companies in their early stages of development when the share price is mostly valued based on their future growth prospects while a small amount of cash is still generated.
Generally, the price-to-cash flow multiple is viewed as a better option that can be used in stock valuations relative to the price-to-earnings (P/E) ratio. One of the main advantages of the P/CF ratio over the P/E ratio is that the company’s cash flows cannot be easily manipulated compared to its earnings.
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