Price to Cash Flow Ratio
Price to cash flow (P/CF) is a valuation ratio used to assess whether a company is a good investment. It is calculated by dividing the stock price of a company by its cash flow per share. Price to cash flow ratio of a company is compared with its competitors to find out whether the company’s stock is overpriced or underpriced with reference to its cash flows generation potential. The company with lower price to cash flow is considered a good investment.
Price to cash flow is similar to price-to-earnings (P/E) ratio in that both compare price of a company’s stock to some performance indicator. They differ in that P/E ratio uses earnings per share (EPS) to evaluate attractiveness of a particular stock, while price to cash flow used cash flows per share generated by the company. Price to cash flow is preferred by some analysts because cash flows are (a) generally less prone to manipulation by the company’s management and (b) are less affected by variation in accounting policies between different companies.
|Price to Cash Flow =||Current Stock Price|
|Cash Flow per Share|
Cash flow per share is most commonly defined as operating cash flow per share for the preceding period. However, it is some times approximated by adding non-cash items to net income and dividing the sum by total number of shares.
Dew, Inc. & Frost, LLC are competitors operating under different accounting regimes. Dew is required to present a full-set of financial statements including the statement of cash flows while Frost is required to only present a balance sheet and income statement.
Current price of Dew, Inc. is $50 per share while its cash flows from operating activities (as reported on its cash flow statement) amount to $30 million. The weighted average number of shares outstanding for the period were 2 million.
Frost on the other hand had net income of $20 million and depreciation and amortization of $5 million. The company has 5 million weighted average number of shares and current stock price of $18.
Calculate price to cash flow for both companies.
In case of Dew, we have a full set of financial statements so we can obtain the operating cash flows figure from the statement of cash flows and calculate price to cash flow as under:
Cash flow per share = cash flows from operating activities/number of shares = $30 million/2 million = $15 per share
Price to cash flow = current stock price/cash flow per share = $50/$15 = 3.33
In case of Frost, we need to estimate operating cash flows and then work out P/CF as follows:
Cash flows = net income + non-cash items = $20 million + $5 million = $25 million
Cash flow per share = $25 million/5 million = $5 per share
Price to cash flow = $18/$5 = 3.6
Stock of Frost, Inc. is overpriced as compared to Dew, Inc. If there is significant fluctuation in EPS and P/E ratio, P/CF can provide useful insight.
Written by Obaidullah Jan, ACA, CFA <--- Hire me on Upwork