Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Price-to-Cash Flow Ratio (P/CF)

What it is:

The price-to-cash flow ratio (P/CF) is used to evaluate the price of a company's stock as compared to the amount of cash flow it generates.

How it works (Example):

The formula for the price-to-cash flow ratio is:

Price-to-Cash Flow Ratio = Price per share / (Cash flow / Shares outstanding)

For example, let's assume that Company XYZ has a share price of $3 and has 10,000,000 shares outstanding. In 2010, Company XYZ generated $5,000,000 of cash flow. Using the formula above, we can calculate Company XYZ's P/CF ratio as:

Price to Cash Flow = $3 / ($5,000,000 / 10,000,000) = 6.0

Many analysts recommend using fully diluted shares outstanding when calculating this ratio.

Why it Matters:

The price-to-cash flow ratio offers investors a somewhat more useful look at a company's value than the P/E ratio, because the price-to-cash flow ratio uses a denominator that excludes the effects of depreciation and the accounting differences related to depreciation. It turns the attention to how much cash a company generates relative to its stock price rather than what it records in earnings relative to stock price.

However, the price-to-cash flow ratio is usually more insightful for companies within the same industry, because capital intensity (and thus depreciation) can vary widely among industries. For example, companies with lower price-to-cash flow ratios tend to be more capital-intensive. Thus, the definition of a "high" or "low" ratio should be made within this context.

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