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Price - Cash Flow Ratio (P/CF)

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How much do you pay for one rupee of a company's cash flow? This is what the price to cash flow ratio, or PCF ratio, tells us. For example, a stock with a PCF ratio of 25 means you are paying 25 rupees for one rupee of cash. The higher the PCF, the more you are paying for a rupee of cash, and the more expensive the stock.

A company's cash flow and a company's earnings are closely related. There are three sources of differences. The first difference comes from non cash earnings such as depreciation. The second difference comes from cash used for investing in a company's future growth. The third difference comes from cash used to pay dividends to shareholders.

Even though a company's cash flow and earnings are not the same, they should follow each other closely. If you notice a company's earnings going up, but its cash flow going down, then this should be investigated closely. Sometimes this could be the case for a fast growing company that uses its cash for expansion. This may be a good thing if the company has good investment opportunities. It may be a bad thing if they are investing in bad projects.

It is also possible that earnings are manipulated. Cash is more difficult to manipulate than earnings, and this can cause a divergence between the two.

Sometimes, you will see a term called cash earnings per share. This is slightly different to total cash flow. Cash earnings per share only looks at cash generated from regular operations. It does not include cash for investments or dividends. The cash earnings per share should be closest to the actual earnings per share.

The Price - Cash Flow Ratio Formula

The PCF ratio is the market price per share divided by the cash flow per share. The market price per share is simply the stock price.

PCF ratio = market price per share / cash flow per share

Calculating the Price - Cash Flow Ratio, An Example

Suppose Bajaj Auto's current stock price is Rs 3,135. And their most recent cash flow per share is Rs 143. Using our formula gives us a PCF ratio of 21.9.

Bajaj Auto PCF = Rs 3,135 / Rs 143 = 21.9

Comparing Price - Cash Flow Ratio with Other Indicators

How does the PCF ratio compare to other indicators, such as price to earnings (PE) or price to book value (PBV)? As discussed, a company's cash flow and earnings are closely related. Typically, the PE ratio is more commonly used than the PCF ratio to value a company. The PCF is valuable in cases where there is a large divergence between earnings and cash flow.

The PBV ratio is the market price per share divided by the book value per share. The book value per share is the value left over if a company's assets are sold and its debts are paid off. It is mostly relevant for firms close to liquidation. If earnings and cash flow are negative, the PE and PCF ratio are both meaningless. In this case, PBV can be used instead.

The biggest advantage of the PCF ratio over both PE and PBV is that cash is difficult to manipulate. Earnings can be manipulated with non cash items such as depreciation or aggressive accruals. The book value can be manipulated with balance sheet items whose current value is not the same as the value stated on the accounts. This is why the PCF ratio is so useful. It allows us to ensure that there is real cash behind a company's earnings.

Price to Cash Flow (P/CF) Financial Ratio Analysis

The Price to Cash Flow ratio (P/CF) is a profitability ratio that compares the price of a company to the underlying cash flow. Find out how this ratio is calculated and how you can use it to evaluate a stock.

FAQs on Price to Cash Flow Ratio

1. What is the Price to Cash Flow Ratio (PCF) Formula?

The price to cash flow ratio measures the value of a stock's market price relative to its last reported cash generated by the company. An excellent tool to determine the value of a stock, the formula is:

Price to Cash Flow Ratio = Operating Cash Flow per Share / Market Price​ of the share.

The formula for operating cash flow is:

Operating Cash flow = Net income+Depreciation/Amortisation+Taxes-Changes in Net working Capital

You can avail this data from the company's annual report or simply log on to Equitymaster. Their company factsheets list out all the essential financial data to analyse a stock.

For instance, you can find the Price-to-Cashflow ratio of Hindustan Unilever, among other things, on its factsheet.

2. Why is the Price to Cash Flow (PCF) ratio important?

While the PCF is an effective tool for comparative analysis, it is only useful in some cases.

The PE ratio represents the amount that investors are currently willing to pay for every rupee of net income the company generates, whereas PCF represents the amount that investors are currently willing to pay for every rupee of cash the company generates.

So since the PCF uses cash from operations to assess the value of a company, it is difficult for the company to manipulate the cash with non-cash expenses like depreciation and non-cash accruals like accounts payable and receivables. However, earnings and book values can fall prey to creative accounting. Hence the PCF is a far more important ratio.

3. How to use the Price to Cash Flow (PCF) ratio to identify Multibagger stocks?

An excellent way to start is to compare them with their peers or the industry average and identify stocks trading at a low PCF valuation. Buying them at a discount to their peers, the industry average or their long-term trend gives you a margin of safety.

A low PCF indicates that the stock is trading at a discount to the company's operating cash flow and vice versa.

Apart from this, look for these characteristics in a stock:

Market leaders with a strong competitive advantage

High growth and rising or robust returns

a strong balance sheet with low or reduced debt

Qualified and honest management

Equitymaster has a screener to help you find high growth companies.

4. What is a good Price to Cash Flow (PCF) ratio?

Considering these are comparative analysis tools, looking at an absolute number, is not helpful.

A PCF of 5x and 15x can be considered low in a high growth industry that averages around 25x.

Therefore, a better way is to compare them with their peers and the industry average. That will determine the correct value of the stock and help you determine if it is undervalued or overvalued.