Price to Cash Flow Ratio - Explained
What is the Price to Cash Flow Ratio?
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Table of ContentsWhat is the Price-to-Cash Flow Ratio?How Does a Price to Cash Flow Ratio Work?How do you Calculate the Price-to-Cash Flow Ratio?Why is Price-To-Cash-Flow Ratio Important?
What is the Price-to-Cash Flow Ratio?
The price-to-cash-flow ratio refers to a multiple that compares the market value of a company relative to its operating cash flow per share. The ratio makes use of the operating cash flow by adding back non-cash expenses like amortization and depreciation to net income. In other words, it helps measure the company's stock current price relative to the amount of cash that the company generates. Another term for the price-to-cash-flow ratio is the P/CF or price/cash flow ratio.
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How Does a Price to Cash Flow Ratio Work?
P/CF is a valuation metric, which determines the company's worth based on the cash flow it has been able to generate. It shows the amount an investor is ready to pay for the cash flow a company has generated. So, investors use this type of ratio to describe the company's valuation with respect to cash. In theory, when the price/cash flow ratio is low, it means that the stock value is better. On the other hand, a high P/CF is an indication that the price of trading of a particular company is high. In this case, it means that there are not enough cash flows that are being generated to support the multiple. However, this is sometimes good, depending on the industry, company, and specific operations.
How do you Calculate the Price-to-Cash Flow Ratio?
To calculate the price-to-cash-flow ratio, you divide the market cap of the company by its operating cash flow using the recent four fiscal quarters or recent fiscal year. You can also divide the per-share stock price by the per-share operating cash flow. Formula: Price to cash flow ratio= Operating cash flow per share/Share price
Why is Price-To-Cash-Flow Ratio Important?
- It provides investors with useful insights about the value of a company than the P/E ratio. It is because the P/CF ratio uses a denominator that excludes the depreciation effects and the accounting differences to do with depreciation.
- It shows how much money the firm is generating in relation to its stock price instead of its earnings recording relative to stock price.
- It provides companies in the same industry insights. For instance, firms with lower price-to-cash-flow ratios have a habit of being more capital-intensive. So, when defining a high or low ratio, it should be made within this setting.
Generally, the P/CF ratio is considered to be a better option, especially when doing stock valuation in relation to the price-to-earnings ratio (P/E). Investors, in most cases, prefer the P/CF ratio over the P/E ratio. The reason is that it is impossible to manipulate the cash flows of the company when comparing it to its earnings.