Price to Free Cash Flow Multiple (P/FCF Multiple): Definition, Formula, and Example

What is the Price to Free Cash Flow Multiple?

The P/FCF multiple measures how much investors pay for each dollar of free cash flow available to shareholders. The formula is P/FCF = Market Cap ÷ Free Cash Flow to Equity (FCFE). This comparative valuation metric focuses on actual cash generation rather than accounting earnings, making it particularly useful for capital-intensive industries.

The P/FCF multiple is similar to the P/E ratio, but instead of using accounting earnings in the denominator, it uses free cash flow to equity, or the cash flow available only to shareholders.

How to Calculate the P/FCF Multiple

The P/FCF multiple is calculated by dividing a company’s market capitalization by its free cash flow to equity (FCFE). 

Where:

• Market capitalization (market cap) is the most recent market value of a company’s outstanding shares expressed as: Market Cap  = Share Price × Shares Outstanding.
• Free Cash Flow to Equity (FCFE), also known as levered free cash flow, represents the cash flow available to shareholders expressed as: FCFE = Net Income + Non-Cash Expenses − CapEx +/− ΔWorking Capital + Net Borrowing.

Step-by-Step Example

Suppose you need to calculate the P/FCF for GreenWave Energy (a fictional company). You collect the following financial data:

• Share price: $50
• Shares outstanding: 20 million
• Net income: $120 million
• Non-cash expenses (depreciation & amortization): $20 million
• Capital expenditures (CapEx): $40 million
• Change in working capital (from previous year): $10 million
• Net borrowing: $5 million

Step 1: Calculate Equity Value (Market Cap)

Market Cap = Share Price × Shares Outstanding

Market Cap = $50 × 20 million = $1 billion

Step 2: Calculate Free Cash Flow to Equity (FCFE)

FCFE = Net Income + Non-cash expenses − CapEx − ΔWorking Capital + Net Borrowing

FCFE = $120 million + $20 million − $40 million − $10 million + $5 million = $95 million

Step 3: Apply the P/FCF Formula

P/FCF = Equity Value (Market Cap) / Free Cash Flow to Equity (FCFE)

P/FCF = $1 billion / $95 million = 10.5x

In this example, GreenWave Energy trades at a P/FCF multiple of 10.5x, meaning investors are paying $10.50 for every $1 of free cash flow to equity.

How to Interpret P/FCF Multiples

On its own, the P/FCF Multiple provides a snapshot of valuation, but it gains real meaning only when compared against peers, historical averages, and growth expectations. 

You compare GreenWave’s P/FCF multiple to its peer companies and find that 10.5x is higher than its peer average P/FCF of 9x. A high P/FCF multiple compared to similar companies might indicate overvaluation. In this case, investors are paying a premium for each dollar of cash flow generation.

However, a lower P/FCF multiple relative to peers and healthy financials signals potential undervaluation. Investors have an opportunity to buy GreenWave shares at a discount to each dollar of free cash flow to equity.

Key Analysis Factors

The P/FCF multiple is most useful when:

• Compared to peers in the same industry.
• Applied to companies with sustainable and predictable FCFE.
• Used alongside other valuation multiples for comprehensive analysis.
• Evaluated against the company’s historical trading ranges.

Limitations of the P/FCF Multiple

The P/FCF multiple is limited by the volatility and variability of free cash flow. Take care when applying it to companies with inconsistent or unpredictable cash generation.

Some common limitations include:

• The P/FCF multiple is highly sensitive to volatile cash flows.
• The multiple is not useful when free cash flow to equity is consistently negative.

Are the P/FCF and P/CF Multiples the Same?

No. The price-to-cash flow ratio (P/CF) multiple and P/FCF are both cash-based comparative valuation metrics, but they use different measures of cash flow. The P/CF multiple compares equity value to operating cash flow per share with the formula: P/CF = Share Price / Operating Cash Flow Per Share. 

The P/CF multiple does not account for capital expenditures or debt payments, making it less precise than the P/FCFE multiple, which includes these investments and borrowings.

Similar to the P/FCF multiple, the application of the P/CF ratio is suitable only in certain cases. For example, the P/CF ratio can make a useful multiple to value the stocks of companies with positive cash flows and large non-cash expenses (e.g., depreciation), which can distort their earnings.

P/FCF vs. P/CF: Side-by-Side Comparison

P/FCF Ratio vs. Levered FCF Yield

The P/FCF ratio and Levered Free Cash Flow Yield are inverses of each other, but they highlight valuation from different angles. The P/FCF ratio and levered FCF yield use the same inputs, but one is expressed as a multiple and the other as a percentage.

The Levered FCF Yield formula is:

FCF Yield = Free Cash Flow to Equity (FCFE) / Equity Value (Market Cap)

Relationship between the two:

• A high P/FCF corresponds to a low FCF yield, which indicates the stock may be expensive.
• A low P/FCF corresponds to a high FCF yield, which suggests the stock may be more attractive.

Use in analysis:

• P/FCF ratio is useful for comparing companies within the same industry or sector.
• FCF yield is helpful when comparing equity returns to bonds, the cost of equity, or other investments.

Why Does the P/FCF Multiple Matter?

The P/FCF multiple connects a company’s market value directly to the cash flow available to shareholders. This makes it a cash-based alternative to earnings multiples like the P/E ratio and a valuable tool for analysts who want to focus on real, distributable cash instead of accounting earnings.

Key points to remember:

• The P/FCF multiple shows how much investors pay for each dollar of free cash flow to equity.
• It provides more insight than earnings-based multiples in capital-intensive industries where cash flow diverges from accounting profits.
• The multiple works best for companies with stable, positive cash flows.
• Analysts use it alongside FCF yield and other multiples to gain a robust view of valuation.

Frequently Asked Questions (FAQs)

1. What does a high P/FCF multiple mean?

A high P/FCF multiple means investors are paying more for each dollar of free cash flow to equity. This often reflects expectations of strong growth or stable future cash flows.

2. How is P/FCF different from the P/E ratio?

The P/FCF multiple uses free cash flow to equity instead of accounting earnings. It focuses on actual cash available to shareholders, making it more useful in capital-intensive industries where earnings and cash flow can diverge.

3. When is the P/FCF multiple most useful?

The P/FCF multiple is most useful when analyzing companies with consistent, positive cash flows. It’s especially relevant in valuation comparisons within the same industry or against historical averages.

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Additional Resources

Comparative Company Analysis

Price-to-Cash Flow Ratio

The Ultimate Cash Flow Guide 

See all Valuation resources