Understand and Calculate the Price-to-Cash-Flow Ratio
The Price-to-Cash-Flow Ratio (P/CF) compares a company’s market value to its cash flow. In general, the lower a company’s P/CF, particularly with regard to the company’s industry average, the more likely that the stock may be undervalued. Like the Price-to-Earnings Ratio (P/E), the P/CF measure provides an indication of relative value. Unlike earnings, though, cash flow is not easily manipulated as it is not affected by depreciation and other non-cash factors.
What is Cash Flow?
In the normal course of business, a company’s cash is received as income and goes out as expenses. This is what is known as known as the cash flow and it is important to monitor when evaluating a company as an investment. The level of cash a company generates is, in fact, one of the more important measures of its financial health. While investors hear a lot about the P/E ratio, it does not offer an accurate measure of a company’s cash.
The formula for calculating the Price to Cash flow Ratio is:
Price to Cash Flow = Share Price / Cash Flow Per share
Many investors prefer the P/CF measure to the P/E ratio because, in using cash flow instead of net income, it adds depreciation and amortization charges back into the measure. Since these expenses don’t involve actual cash, the company has more cash than the net income figure indicates.
Because the price to cash flow ratio is less susceptible to variations in industry accounting practices, it is often seen as a better approach for comparing valuations across industries.
Price to Cash Flow Ratio for Different Industries
Price-to-cash-flow ratios can vary widely among industries as capital-intensive industries tend to see lower measures. The spectrum currently runs from an average of about 5 for highly capital-intensive industries to close to 40 for those industries with much less of a capital requirement. The current measure for the S&P 500 is about 15.
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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.
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