The price-to-cash-flow-ratio shows the difference between the price and the cash flow of a stock. The P/CF ratio is primarily used in fundamental analysis.
You can use P/CF ratios to determine how profitably a company will perform in the future. P/CF ratios also enable the comparison of different companies on national and international levels.
P/CF ratios make it possible for investors to quickly judge the attractiveness of a specific stock compared to other stocks. The lower the P/CF ratio, the lower the valuation of the stock.
To find the price-to-cash-flow ratio, the price of the stock in question must be divided by the cash flow of the same stock. A stock’s cash flow is determined by dividing the issuing company’s cash flow by its total number of shares.
However, attention must be paid to which type of cash flow rating is used for the calculation. The performance reports issued by most large companies only mention “free cash flow”. This term refers to the total assets generated by a company minus costs. However, it includes earnings generated through investments and rentals of existing assets.
A more accurate comparison between a company and its competitors can be found by using its operative cash flow. This is new income generated through the company’s business operations.
Determining a stock’s P/CF ratio requires more effort, compared to finding other key indicators. But this ratio is very useful in the process of comparing companies in the same industry and determining which stocks are under-rated, and therefore suitable for long-term investment.
Unlike the price-earnings ratio (P/E), the P/CF ratio is not as easily manipulated. A company’s earnings can be influenced by depreciation and special provisions. Cash flow, on the other hand, only includes income which is actually included in debit/credit accounts.
Because of this, the P/CF ratio can also be used to rate companies which have not made a profit. This can’t be accomplished using P/E ratios.