Calculate and Interpret the Price/Cash Flow Ratio
The price/cash flow (P/CF) ratio is used to compare the market value of a company to its cash flow. Like the Price/Earnings (P/E) ratio, P/CF provides investors with a sense of relative value. While the P/E ratio is probably the most commonly used measure of valuation, many analysts prefer the P/CF ratio since it removes the effects of non-cash factors like depreciation. Because accounting practices regarding depreciation can vary by jurisdiction, the P/CF ratio can help investors evaluate international companies with greater ease.
What is Cash Flow?
A company’s cash flow is the movement of cash into and out of the business. Cash flow is usually measure over a specified period of time and the observation of cash flows can help investors recognize liquidity issues within a company. It’s important to note that even profitable companies can find themselves in trouble due to cash shortages.
Calculate the Price/ Cash Flow Ratio
The formula for the price/cash flow ratio can be written as:
Price/Cash Flow = Share Price / Cash Flow per Share
The P/CF ratio is calculated by dividing the current stock price by the company’s cash flow from operations. Some investors prefer a variation of the formula which utilizes free cash flow (FCF) instead.
Using the Price/Cash Ratio for Stock Valuation
The average P/CF ratio tends to vary among industries. For more capital-intensive companies, P/CF ratios are often lower than for those businesses that have lower capital requirements. Like many financial ratios, P/CF is best used to compare companies within the same industry or to evaluate the performance of any particular company over time.
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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.
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