Price-to-Cash Flow Ratio (P/CF) Definition, Formula & Calculation

KEY TAKEAWAYS

• The price-to-cash flow ratio (P/CF) is a valuation method that measures how much cash a company is generating relative to its stock price.
• A high P/CF ratio is generally seen as worse, while a low P/CF ratio is more desirable.
• The P/CF ratio can be used to measure a company’s value, compare companies and industries, and compare companies with different levels of debt.
• There are three main types of cash flow: operating cash flow, free cash flow, and cash flow from financing.

What is Price-to-Cash Flow Ratio?

The price-to-cash flow ratio (P/CF) is a valuation metric that measures the value of a company. It helps find true stock valuation. It’s calculated by dividing the company’s stock price by its cash flow from operations. It’s a useful metric because it measures the amount of cash a company is generating relative to its stock price. The higher the P/CF ratio, the more expensive the company’s stock is compared to the amount of cash it’s generating.

The Formula for the Price-to-Cash Flow Ratio

The price-to-cash flow formula is calculated by dividing the company’s stock price by its cash flow from operations. This can be expressed using the following formula:

Example of the Price-to-Cash Flow (P/CF) Ratio

Say company A’s stock price is $10. Its positive cash flow from operations is $1. The P/CF ratio would be 10 ($10 ÷ $1). Conversely, if a company’s stock price is $50 and its cash flow from operations is $5, the P/CF ratio for company A would also be 10. You can see how the numbers and earnings are different, but the actual cash flow can be seen as the same.

Contrarily, say a company has a price of $1 and a cash flow of $0.05. 1/.05 = 20. So even though the stock price is cheaper, investors may see this company as less valuable due to a worse cash ratio.

Advantages and Disadvantages of P/CF

Publicly-traded companies use a variety of financial metrics to measure their value. The price-to-cash flow ratio is one such metric for companies looking to understand their current market valuation. It has both advantages and disadvantages.

Advantages of P/CF

The advantages of the price-to-cash flow earnings ratio include:

• The cash flow ratio formula is easy to understand.
• It’s a relative measure, which makes it useful for comparisons and helps retail investors make decisions.
• It measures the amount of cash a company is generating relative to its stock price.
• The higher the P/CF ratio, the more expensive the company’s stock is with respect to cash that’s being generated.

Disadvantages of P/CF

The disadvantages of the price-to-cash flow ratio include:

• It doesn’t take into account a company’s assets or liabilities.
• It doesn’t necessarily indicate whether a company is overpriced or underpriced. Always review all financial statements and income statements to set appropriate investor expectations.
• It can be influenced by short-term factors like random market movements. These include changes in operating cash flow.
• Not a good indicator of future growth prospects or future cash flows.

Applications of the Price-to-Cash Flow Ratio

The price-to-cash flow ratio should not be used in isolation. It should be used in conjunction with other financial metrics when assessing a company’s value. It’s a useful metric for comparing peer companies across many industries and sectors.

Assessing a company’s value. P/CF can be used to help assess whether a company is overpriced or underpriced. However, it’s not a substitute for assessing value on a whole-company basis. 

Making comparisons between companies. P/CF can be used to compare companies in terms of the amount of cash they’re generating relative to their stock prices.

Industry comparisons. P/CF can be used to compare overall industries. By analyzing numerous businesses within different sectors, you can get an idea of how the sectors compare.

Comparing the value of companies with different levels of debt. When a company has a lot of debt, the price-to-cash flow ratio can be a useful measure for comparing it to companies with less debt.

The P/CF Ratio vs the Price-to-Free-Cash Flow Ratio

The price-to-cash flow ratio and the price-to-free cash flow ratio are very similar. There are a couple of main differences First, the price-to-free cash flow ratio uses earnings before interest and taxes (EBIT). The P/CF ratio uses cash flow from operations. The second difference is that the price-to-free cash flow ratio uses all of a company’s cash, while the P/CF ratio only uses operating cash flow.

Both ratios can be used to measure a company’s value. However, the price-to-cash flow ratio is more commonly used because it’s easier to understand.

What are the Different Types of Cash Flow?

There are three main types of cash flow: operating cash flow, free cash flow, and cash flow from financing.

• Operating Cash Flow (OCF): This is the amount of cash generated by a company’s normal business operations.
• Free Cash Flow (FCF): This is the amount of cash left over after a company has paid for its capital expenditures and other investments.
• Cash Flow from Financing (CFF): This is the amount of cash generated or used by a company’s financing activities. This includes issuing debt or issuing stock.

Summary

Overall The price to cash flow ratio gives investors and other potential shareholders a clear value of a company in relation to the price of its stock. While it’s great to get a quick glance at the company’s value, it should be paired with other financial metrics to get a full understanding.