What is a Price-to-Cash Flow Ratio (P/CF)?
The price-to-cash flow ratio (P/CF) is used to evaluate the price of a company's stock as compared to the amount of cash flow it generates.
How Does a Price-to-Cash Flow Ratio (P/CF) Work?
The formula for the price-to-cash flow ratio is:
Price-to-Cash Flow Ratio = Price per share / (Cash flow / Shares outstanding)
For example, let's assume that Company XYZ has a share price of $3 and has 10,000,000 shares outstanding. In 2010, Company XYZ generated $5,000,000 of cash flow. Using the formula above, we can calculate Company XYZ's P/CF ratio as:
Price to Cash Flow = $3 / ($5,000,000 / 10,000,000) = 6.0
Many analysts recommend using fully diluted shares outstanding when calculating this ratio.
Why Does a Price-to-Cash Flow Ratio (P/CF) Matter?
The price-to-cash flow ratio offers investors a somewhat more useful look at a company's value than the P/E ratio, because the price-to-cash flow ratio uses a denominator that excludes the effects of depreciation and the accounting differences related to depreciation. It turns the attention to how much cash a company generates relative to its stock price rather than what it records in earnings relative to stock price.
However, the price-to-cash flow ratio is usually more insightful for companies within the same industry, because capital intensity (and thus depreciation) can vary widely among industries. For example, companies with lower price-to-cash flow ratios tend to be more capital-intensive. Thus, the definition of a "high" or "low" ratio should be made within this context.
Personalized Financial Plans for an Uncertain Market
In today’s uncertain market, investors are looking for answers to help them grow and protect their savings. So we partnered with Vanguard Advisers -- one of the most trusted names in finance -- to offer you a financial plan built to withstand a variety of market and economic conditions. A Vanguard advisor will craft your customized plan and then manage your savings, giving you more confidence to help you meet your goals. Click here to get started.
Read This Next
Stocks can be put into various categories in order to make it easier to identify them. Although there are a number of classifications, some...
Read More →
First published in 1996, this wildly popular book has sold over three...
Read More →
Good habits are the key to financial security. If you want to put yourself in position to weather any financial storm, you need to understand and follow only four good habits: 1. Work hard...
Read More →
Financial ratios are tools that allow analysts and investors to convert raw data from financial statements into concise, actionable information. This information is used to...
Read More →
