Price to Cash Flow Ratio

What is Price to Cash Flow Ratio?

Price to Cash Flow Ratio is the value indicator that pitches the current market price of the share to the operational cash flow so as to represent what percentage of the price is explained by the cash flow and what percentage isn’t.

In other words, the price to cash flow ratio is one of the most important investment valuation tools and is calculated as the ratio of current stock price to its cash flow from operations per share. In the case of the P/CF ratio, we consider the cash flow from operations, which is the exact measure of how much cash came in and went out from core operations. Many financial experts, therefore, consider this ratio as a more accurate measure of judging the attractiveness of an investment than price to earnings ratio.

Unlike cash flow, earnings can be easily manipulated because earnings (net income) easily get affected by depreciation and other non-cash factors.

Let us have a look at the PE RatioPE RatioThe price to earnings (PE) ratio measures the relative value of the corporate stocks, i.e., whether it is undervalued or overvalued. It is calculated as the proportion of the current price per share to the earnings per share. read more of Chevron.

Currently, the PE ratio of Chevron is at 149.88x. What do you think about Chevron’s valuation? A definite SELL? However, most of the analysts have given Chevron either a Strong Buy or Buy rating. None of the analysts actually gave Chevron a SELL rating. Are they crazy?

Why did they give BUY ratings to Chevron? 

source: Yahoo Finance

Of course, these analysts are looking at ratios beyond Price to Earnings ratio, and in the Oil & Gas sector, other valuation multiples like EV/boe (Enterprise value to barrels of oil equivalent), EV/EBITDAEV/EBITDAEV to EBITDA is the ratio between enterprise value and earnings before interest, taxes, depreciation, and amortization that helps the investor in the valuation of the company at a very subtle level by allowing the investor to compare a specific company to the peer company in the industry as a whole, or other comparative industries.read more, and Price to Cash Flows become rather important.

From the graph above, we note that Chevron’s P/CF is at around 16.01x.

source: Chevron SEC Filings

We note from Chevron’s Cash flow from operations that Depreciation, Depletion, and Amortization numbers were very high. In fact, in 2015, it was higher than the overall Cash flow from Operations.

Through this price to cash flow ratio, you would be able to compare the cash flow per share with the price per share, which will give you an idea about how much value you would get out of paying the kind of price you are going to pay.

If you want to invest in a company or a project, the P/CF ratio is one of the first ones you should consider calculating.

Formula

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For eg:
Source: Price to Cash Flow Ratio (wallstreetmojo.com)

To get a thorough idea about this ratio, we need to look at two separate ratios. Understanding these two ratios will help us figure out how to calculate the price to cash flow ratio for an investment.

Let’s look at the price to cash flow ratio first –

Price to Cash Flow = Share Price / Cash Flow per share.

This ratio is super useful for investors as they can understand whether the company is over-valued or under-valued by using this ratio.

However, to find out this ratio, we need to calculate “cash flow per share.”

To calculate “cash flow per shareCash flow per share of the company shows the cash flow portion of the company, allocated against each of the common stock presents in the company. Cash flow per share = (operating cash flow – preferred dividends)/Weighted average number of shares.read more,” we need two things. First, we need to know the “operating cash flow,” which we will be able to see in the cash flow statement of the company for that period. Second, we need to know the number of “outstanding shares.”

So to calculate, the “cash flow per share,” we would do the following –

Cash flow per share = Operating Cash Flow / Outstanding Shares.

Once we know the cash flow per share, we would be able to calculate the price to cash flow ratio very easily.

Interpretation

Many investors get busy in calculating price to earnings ratio. But if you look at the price t earnings ratio, you would see that many companies can manipulate it to attract more investors. For example, as there are many non-cash factors affecting the “net income,” companies that want to manipulate the “net income” can increase or decrease the non-cash factors. Thus, the price to earnings ratio is not always able to provide an accurate picture of a company or of new investment.

However, when we look at the cash flow, it changes the game completely. In the cash flow statementCash Flow StatementStatement of Cash flow is a statement in financial accounting which reports the details about the cash generated and the cash outflow of the company during a particular accounting period under consideration from the different activities i.e., operating activities, investing activities and financing activities.read more, no non-cash factors would be included. Thus, there is no way one can manipulate the net cash flow at the end of the period. So if we can calculate the “operating cash flow”The operating cash flow formula depicts the operational cash flow acquired after deducting the operating expenses from the total revenue. It can also be evaluated as the aggregate of net income, changes in assets and liabilities and non-cash expenses.read more using the cash flow statement and divide it by the number of “outstanding shares,” then we will get a concrete idea about how much cash flow we can generate per share. Then we can compare the same with the price per share to conclude whether the investment is a good one or not.

If we try to find an optimal level of ratio, then we need to look at a particular sector. For example, if we look at a new technology start-up, its growth would be much faster, resulting in a higher price to cash flow ratio, whereas, if we look at a utility company that is operating for decades, price to cash flow ratio would be much lower. In the case of a technology start-up, as its growth is tremendous, the investors would put more valuation to it than the utility company, which has stable cash flow but fewer opportunities for growth.

Basic Examples

We will look at a few examples so that we can understand the price to cash flow ratio from all angels.

Example # 1

The G Corporation has the following information. Use the information below to find out the price to cash flow ratio.

Details	In US $
Price per share	10/share
Cash Flow per share	4/share

From the example, we can directly calculate this ratio.

Details	In US $
Price per share (A)	10/share
Cash Flow per share (B)	4/share
P/CF Ratio (A/B)	2.5

Depending on which sector G Corporation belongs, we can compare the price to cash flow ratio and find out whether it is a good number or not.

Example # 2

MNC Company has provided the following information –

Details	In US $
Price per share	12/share
Operating Cash Flow	600,000
Outstanding Shares	500,000

calculate Price to Cash Flow Ratio.

In the above, for example, we have two things to calculate. First, we need to calculate the cash flow per share and then the price to cash flow ratio.

Here’s the calculation of cash flow per share –

Details	In US $
Operating Cash Flow (1)	600,000
Outstanding Shares (2)	500,000
Cash Flow per share (1/2)	1.20/share

Now we can calculate the P/CFratio –

Details	In US $
Price per share (A)	12/share
Cash Flow per share (B)	1.20/share
P/CF Ratio (A/B)	10

Again, a similar thing is applicable in this regard as well. Depending on the sector this company belongs to, we need to compare the price to cash flow ratio and find out whether it’s a good number or not.

Example # 3

We have been given the following information by ABC Company –

Details	In US $
Price per share	12/share
Outstanding Shares	30,000
Net Income	70,000
Loss on Sale of Property	2,000
Decrease in Accounts ReceivablesAccounts ReceivablesAccounts receivables refer to the amount due on the customers for the credit sales of the products or services made by the company to them. It appears as a current asset in the corporate balance sheet.read more	1,000
Increase in Inventories	2,000
Increase in Accrued Interest Payable	700
Increase in Account PayablesAccount PayablesAccounts payable is the amount due by a business to its suppliers or vendors for the purchase of products or services. It is categorized as current liabilities on the balance sheet and must be satisfied within an accounting period.read more	1,000
Deferred TaxesDeferred TaxesDeferred Tax is the effect that occurs in a firm as a result of timing differences between the date when taxes are actually paid to tax authorities by the company and the date when such tax is accrued. Simply put, it is the difference in taxes that arises when taxes due in one of the accounting period are either not paid or overpaid.read more	500
Depreciation & amortization	3,000

calculate the Operating Cash Flow, Cash Flow per share, and also the P/CF ratio.

From the above example, first, we need to calculate the operating cash flow –

Details	In US $
Net Income	70,000
Adjustments:
Depreciation & amortization	3,000
Deferred Taxes	500
Decrease in Accounts Receivables	1,000
Increase in Inventories	(2,000)
Increase in Accrued Interest Payable	700
Increase in Account PayablesAccount PayablesAccounts payable is the amount due by a business to its suppliers or vendors for the purchase of products or services. It is categorized as current liabilities on the balance sheet and must be satisfied within an accounting period.read more	1,000
Loss on Sale of Property	2,000
Net Cash Flow from Operating Activities	76,200

So now we know that the operating cash flow is the US $76,200.

We also know the number of outstanding shares. So, it would be easier to calculate cash flow per share –

Details	In US $
Operating Cash Flow (1)	76,200
Outstanding Shares (2)	30,000
Cash Flow per share (1/2)	2.54/share

Now we would be able to calculate the price to cash flow ratio with ease –

Details	In US $
Price per share (A)	12/share
Cash Flow per share (B)	2.54/share
Ratio (A/B)	4.72

So the ratio is 4.72. Depending on the sector ABC Company belongs to, we can compare and find out whether 4.72 is a good enough number in regards to price to cash flow ratio or not.

Practical Example – Chevron

Let us now calculate Chevron’s Price to Cash Flow Ratio.

Current Price = $115.60

Chevron P/CF – 2013

• Cash flow from Operations (2013) = $35,002 million
• Number of Shares in 2013 = 1917 million
• Cash Flow Per Share (2013) = 18.25
• P/CF (2013) = 115.60/18.25 = 6.33x

Chevron Price to Cash Flow – 2014

• Cash flow from Operations (2014) = $31,475 million
• Number of Shares in 2014 = 1884 million
• Cash Flow Per Share (2014) = 16.70
• P/CF (2014) = 115.60/16.70 = 6.91x

Chevron Price to Cash Flow – 2015

• Cash flow from Operations (2015) = $19,456 million
• Number of Shares in 2015 = 1886 million
• Cash Flow Per Share (2015) = 10.31
• P/CF (2015) = 115.60/10.31 = 11.20x

Please note that the P/CF that we earlier saw for Chevron (16.01x) is the trailing twelve month Price to Cash Flow.

Oil & Gas Companies

Now that we have a fair understanding of the PCF ratio, let us now compare Oil & Gas companies – Exxon, Chevron, and BP PCF ratio.

We note that for all three companies, the Price to Cash flow ratio has been rising for the past 2-3 years.

Why do you think this is so?

source: ycharts

There has been a slowdown in commodities (Oil) since 2013-2014. Oil prices directly affect their cash flows. Due to lower oil prices, these companies saw a significant decline in their cash flow from operations.

source: ycharts

With this reduced cash flow from operationsCash Flow From OperationsCash flow from Operations is the first of the three parts of the cash flow statement that shows the cash inflows and outflows from core operating business in an accounting year. Operating Activities includes cash received from Sales, cash expenses paid for direct costs as well as payment is done for funding working capital.read more in the recent quarters, the Price to Cash Flow ratio for these companies who an upward trend (the higher the P/CF ratio, expensive the firm is).

Oil E&P Companies

P/CF is one of the most important tools to value Oil & Gas companies. This is because the best way to measure the Oil company’s performance is to look at its Core Cash Flows. These companies require a large asset base and tend to accumulate high levels of debt to finance capital assets. Increased debt levels mean increased interest and debt repayments. Tracking these core cash flows provides us key insights into the company’s ability to service these debts. (DSCRDSCRDebt service coverage (DSCR) is the ratio of net operating income to total debt service that determines whether a company's net income is sufficient to cover its debt obligations. It is used to calculate the loanable amount to a corporation during commercial real estate lending.read more).

On the other hand, Net income (Net profit) is not a cash measure and can remain steady (or show an increasing trend).  However, if cash flows are declining, then it is a clear indication that the company may find it difficult to make its debt repayments.

The table below provides us with Price to Cash Flow ratios (TTM) of top Oil Exploration and Production companies.

S. No	Name	Market Cap ($ mn)	P/CF (TTM)
1	ConocoPhillips	61,778	13.62x
2	EOG Resources	60,638	26.52x
3	CNOOC	57,131	4.60x
4	Occidental Petroleum	52,523	15.29x
5	Anadarko Petroleum	39,224	16.81x
6	Canadian Natural	33,487	11.37x
7	Pioneer Natural Resources	31,220	20.90x
8	Mitsui & Co	24,808	8.43x
9	Devon Energy	24,133	9.67x
10	Apache	23,608	11.09x
		Average Price / Cash Flow	13.83x

as of January 20, 2017

Some important points to note here –

• Average Price to Cash flow ratio of these top companies is around 13.83x
• EOG Resources and Pioneer Natural Resources are the two outliers in this sector, with the P/CF ratio of 26.52x and 20.90, respectively.
• If we remove these outliers, then the Average PCF ratio comes out to be 11.36x

Software Application

Unlike Oil & Gas companies, Software Application companies have an asset-light model. Instead of tangible assetsInstead Of Tangible AssetsAny physical assets owned by a firm that can be quantified with reasonable ease and are used to carry out its business activities are defined as tangible assets. For example, a company's land, as well as any structures erected on it, furniture, machinery, and equipment.read more, we find that its assets consist of intangible assets (patents, IPs, copyrights). Another characteristic of Software companies is that they don’t rely heavily on debt (like the Oil & Gas companies). Due to this, Software companies are not valued on the basis of the P/CF ratio.

Instead, analysts use multiples like PE, PEGPEGThe PEG ratio compares the P/E ratio of a company to its expected rate of growth. A PEG ratio of 1.0 or lower, on average, indicates that a stock is undervalued. A PEG ratio greater than 1.0 indicates that a stock is overvalued.read more, EV/EBIT, EV/Customer, etc. to value such companies.

(also, have a look at Enterprise Value vs. Equity Value multiplesEnterprise Value Vs. Equity Value MultiplesThe equity value is of two types: market equity value which is the total number of shares multiplied by market share price, and the book equity, which is the value of assets minus liabilities. In contrast, enterprise value is the total value of equity plus debt minus the company's amount of cash.read more)

The table below provides us with a Price to Cash Flow ratios (TTM) of top Software Application Companies.

S. No	Name	Market Cap ($ mn)	Price to Cash Flow (TTM)
1	SAP	110,117	23.98x
2	Adobe Systems	54,286	25.15x
3	Salesforce.com	52,650	27.75x
4	Intuit	29,761	21.85x
5	Dassault Systemes	19,384	28.06x
6	Autodesk	17,800	55.20x
7	Check Point Software Tech	16,850	18.09x
8	Symantec	16,558	–
9	Workday	16,490	47.60x
10	ServiceNow	13,728	102.65x
		Average Price / Cash Flow	38.93x

source: ycharts

Some important points to note here –

• The average ratio of these top companies is around 38.93x. This is very high.
• Autodesk, Workday, and ServiceNow are the three outliers in the Software application category with P/CF multiple of 55.20x, 47.60x, and 102.65x, respectively.

Utilities

A key characteristic of Utility companies is that they are Capital IntensiveCapital IntensiveCapital intensive refers to those industries or companies that require significant upfront capital investments in machinery, plant & equipment to produce goods or services in high volumes and maintain higher levels of profit margins and return on investments. Examples include oil & gas, automobiles, real estate, metals & mining.read more Model with steady cash flows and high levels of debt in the balance sheet. As a result, we can apply P/CF to value Utility companies.

The table below provides us with Price to Cash Flow ratios (TTM) of top Utility Companies sorted by Market Capitalization

S. No	Name	Market Cap ($ mn)	P/CF (TTM)
1	NextEra Energy	55,736	8.02x
2	Duke Energy	53,131	7.74x
3	Southern	48,069	8.45x
4	Dominion Resources	47,395	10.46x
5	National Grid	45,950	6.47x
6	Exelon	45,333	4.88x
7	ENEL S.p.A	44,733	3.42x
8	Exelon	32,998	3.55x
9	Dominion Resources	31,494	6.95x
10	PG&E	30,896	7.50x
		Average Price / Cash Flow	6.74x

source: ycharts

• Average Price to a Cashflow ratio of these top Utility companies is around 6.74x

Limitations

There is only one limitation to this ratio. It also has one loophole, and that is this – it doesn’t take capital expenditure into account.

If you want to know a rigorous measure of this ratio, we need to extend beyond price to cash flow ratio (P/CF), and we need to calculate free cash flow and compare it with the price per share.

Free cash flow is the amount of cash flow that is available to business after deducting the CapexCapexCapex or Capital Expenditure is the expense of the company's total purchases of assets during a given period determined by adding the net increase in factory, property, equipment, and depreciation expense during a fiscal year.read more. Calculating Free Cash Flow may sound complicated. But here’s the deal

All we need to do is to go back to the income statement of the companyIncome Statement Of The CompanyThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements.read more and pick net income. Then we need to add back depreciation and amortization as they are non-cash charges. Next, we will take into account any changes in the working capital, and thus, we would get the operating cash flow. From operating cash flow, if we deduct the capital expenditure (new machinery), then we would get free cash flow.

To understand this, we can take an example and illustrate the same.

An Ice Cream Company has an operating cash flow of US $100,000. And now, the company has decided to buy a new refrigerator as the demand for their ice-creams has increased. Thus, they have bought a refrigerator of US $30,000. So what would be the free cash flow of this ice cream company? It would be = US $(100,000 – 30,000) = US $70,000. With the free cash flow of US $70,000, the ice cream company now will be able to pay off its debt (if any) and would be able to bear other expensesBear Other ExpensesOther expenses comprise all the non-operating costs incurred for the supporting business operations. Such payments like rent, insurance and taxes have no direct connection with the mainstream business activities.read more.

So finally, what is a more rigorous, accurate ratio? It is the price to free cash flow ratio.

Price to Free Cash Flow = Share Price / Free Cash Flow per share.

All we need to do is to divide the free cash flow by the outstanding sharesOutstanding SharesOutstanding shares are the stocks available with the company's shareholders at a given point of time after excluding the shares that the entity had repurchased. It is shown as a part of the owner's equity in the liability side of the company's balance sheet.read more of the company. And that will give a more accurate picture of whether to invest in a company or not.

In the final analysis

It can be easily said that the price to cash flow ratio is very useful for investors. It gives an almost accurate picture of how good an investment is. And the P/CF is useful because there is little or no chance of manipulation in the cash flow.

If, as an investor, you would like to invest in a new project or a new start-up, use this ratio as the measuring grid. You can also use price to earnings ratio. But the price to cash flow ratio is, by all means, a better measuring grid.

Price to Cash Flow Ratio Video

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