The stock price to cash flow ratio (P/CF) is a valuation metric that compares the market value of a company or a stock to its operating cash flow. Operating cash flow is the amount of cash generated by a company’s core business activities, excluding investing and financing activities. The P/CF ratio measures how much investors are willing to pay for each dollar of operating cash flow generated by the company.
The P/CF ratio is useful for valuing companies that have positive cash flow but are not profitable on an accounting basis due to large non-cash expenses, such as depreciation and amortization. The P/CF ratio is also less prone to manipulation than the price-to-earnings ratio (P/E), since earnings can be affected by accounting choices and assumptions.
The P/CF ratio can be calculated in two ways:
- On a per-share basis, by dividing the current share price by the operating cash flow per share
- On a total basis, by dividing the market capitalization by the total operating cash flow
The formula for the P/CF ratio on a per-share basis is:
The formula for the P/CF ratio on a total basis is:
Example
Let’s assume that we want to calculate the P/CF ratio for Company A, which has the following data:
- Current share price: $50
- Number of shares outstanding: 100 million
- Operating cash flow for the last 12 months: $400 million
To calculate the P/CF ratio on a per-share basis, we need to first find the operating cash flow per share, which is:
Then, we can plug in the values into the formula:
This means that investors are willing to pay $12.5 for every dollar of operating cash flow generated by Company A.
To calculate the P/CF ratio on a total basis, we need to first find the market capitalization, which is:
Then, we can plug in the values into the formula:
We get the same result as the per-share basis, which is expected, since the two methods are equivalent.
Interpretation
The P/CF ratio can be used to compare the relative value of different companies or stocks within the same industry or sector. Generally, a lower P/CF ratio implies that a company or a stock is undervalued, while a higher P/CF ratio implies that a company or a stock is overvalued. However, the P/CF ratio should not be used in isolation, but rather in conjunction with other valuation metrics and factors, such as growth prospects, profitability, risk, and industry averages.
The P/CF ratio can also be used to assess the financial health and performance of a company. A positive and stable P/CF ratio indicates that a company is generating enough cash flow to cover its operating expenses and invest in its future growth. A negative or declining P/CF ratio indicates that a company is struggling to generate cash flow from its operations and may face liquidity or solvency issues.
Excel Calculation
To calculate the P/CF ratio in Excel, we can use the following steps:
- Enter the data for the share price, number of shares outstanding, and operating cash flow in separate cells
- Calculate the operating cash flow per share by dividing the operating cash flow by the number of shares outstanding
- Calculate the P/CF ratio on a per-share basis by dividing the share price by the operating cash flow per share
- Calculate the market capitalization by multiplying the share price by the number of shares outstanding
- Calculate the P/CF ratio on a total basis by dividing the market capitalization by the operating cash flow
The following table shows an example of the Excel calculation for Company A:
| Share Price | Number of Shares Outstanding | Operating Cash Flow | Operating Cash Flow per Share | P/CF (Per-Share Basis) | Market Capitalization | P/CF (Total Basis) |
|---|---|---|---|---|---|---|
| $50 | 100 million | $400 million | $4 | 12.5 | $5000 million | 12.5 |
We can also use the following formulas in Excel to calculate the P/CF ratio:
- Operating Cash Flow per Share:
=C2/B2 - P/CF (Per-Share Basis):
=A2/D2 - Market Capitalization:
=A2*B2 - P/CF (Total Basis):
=E2/C2
Alternative Approaches
The P/CF ratio is not the only valuation metric that uses cash flow as a denominator. Some alternative approaches are:
- Price to Free Cash Flow Ratio (P/FCF): This ratio compares the market value of a company or a stock to its free cash flow, which is the operating cash flow minus the capital expenditures. The P/FCF ratio measures how much investors are willing to pay for each dollar of free cash flow generated by the company. The P/FCF ratio is more conservative than the P/CF ratio, as it accounts for the cash outflows required to maintain or expand the company’s assets.
- Enterprise Value to Operating Cash Flow Ratio (EV/OCF): This ratio compares the enterprise value of a company to its operating cash flow. The enterprise value is the market value of the company’s equity plus the market value of its debt minus its cash and cash equivalents. The EV/OCF ratio measures how much it would cost to acquire the entire company in relation to its operating cash flow. The EV/OCF ratio is more comprehensive than the P/CF ratio, as it accounts for the capital structure and the cash position of the company.
Conclusion
The stock price to cash flow ratio (P/CF) is a valuation metric that compares the market value of a company or a stock to its operating cash flow. The P/CF ratio is useful for valuing companies that have positive cash flow but are not profitable on an accounting basis due to large non-cash expenses, such as depreciation and amortization. The P/CF ratio is also less prone to manipulation than the price-to-earnings ratio (P/E), since earnings can be affected by accounting choices and assumptions.
The P/CF ratio can be calculated in two ways: on a per-share basis or on a total basis. The P/CF ratio can be used to compare the relative value of different companies or stocks within the same industry or sector, as well as to assess the financial health and performance of a company. However, the P/CF ratio should not be used in isolation, but rather in conjunction with other valuation metrics and factors, such as growth prospects, profitability, risk, and industry averages.
The P/CF ratio can be easily calculated in Excel by using the data for the share price, number of shares outstanding, and operating cash flow. Some alternative approaches to the P/CF ratio are the price to free cash flow ratio (P/FCF) and the enterprise value to operating cash flow ratio (EV/OCF), which use different measures of cash flow and market value.
