Price to Cash Flow Ratio (P/CF Ratio) is not a commonly used indicator when valuing a company. However, it is still a very useful metric especially for investors interested with the cash generation ability of a business. The formula for Price to Cash Flow is:
P/CF Ratio = Share Price / (Cash Flow Per Share)
Typically, a lower ratio indicates a “cheaper” valuation while a higher ratio indicates an “expensive” stock. This ratio might be useful to investor when valuing a company which is cash flow positive but is not profitable yet. For example, COMPANY A might be making a loss of $5 million dollars but produced an operating cash flow of $10 million after adjusting for its non-cash expenses such as depreciation and amortization. The company has a share price of $1.00 and 100 million shares outstanding.
Therefore, to calculate the P/CF ratio of the company, we would simply plug in the numbers to the formula: P/CF = 1.00 / (10/100) = 10
Thus, it can be said that COMPANY A has a Price to Cash Flow Ratio of 10x.
What is the downside of using the P/CF?
The risk of using this ratio is that the cash flow of the company might not be consistent. If the cash flow fluctuates wildly year to year, the ratio of a particular year might be useless for an investor. Another risk is that the ratio does not take into account the capital expenditure of the company and might not be an accurate presentation of the nature of the business. A more demanding metric to use can be the Price To Free Cash Flow Ratio (P/FCF) which takes into account the capex of the business.
Value In Action
P/CF ratio is a good alternative to value a company. However, as we discussed, there are risks involved in using this metric and investors should be aware of them.
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