Price/Cash Flow Ratio

Definition

Price/cash flow ratio is an investment valuation ratio used by investors to evaluate the attractiveness of investing in a company’s shares. This ratio considers cash flows only and removes the effect of non cash items like depreciation. It is calculated by dividing market value of a company’s share to operating cash flow that company generates per share. Operating cash flow per share figure is calculated by dividing “Net Cash Flows from Operating Activities (Cash Flow Statement)” to “Common Shares Outstanding (Income Statement)”. The formula is:

CFPS = (Operating Cash Flow – Preferred Dividends) /Common Shares Outstanding

Free cash flows can also be used instead of Operating cash flows to calculate the cash flow per share value. However, due to the complexity in the calculation most of the financial analysts/investors use price/cash flow ratio.

Price/cash flow ratio is an alternative method to P/E ratio. Investors prefer to use P/CF ratio as it is hard to manipulate cash figures as compare to “earnings (EPS)” figure which can easily be manipulated or can be affected by non cash items, for example, Depreciation, Amortization. This makes P/CF ratio more reliable to use as oppose to P/E ratio. Despite all these considerations, P/E ratio is still widely used and a recognized method of investment valuation.

Calculation (formula)

Price/Cash Flow Ratio = Stock Price per Share / Operating Cash Flow per Share

Most of the Financial Experts advice to use P/CF ratio for better and realistic assessment. In case of big companies, depreciation and amortization figure is very high which greatly affects the net income figure. This reflects in the P/E ratio and leads to a wrong/inappropriate investment decision. On the other side, P/Cash Flow ratio removes the effect of non cash items and gives realistic and reliable results without any deliberate or intentional manipulation. This helps investors judging the actual condition of a company. The standard Price/Cash flow ratio is 10 to 1.