Price multiples are commonly used to determine the equity value of a company. The ease and simplicity of these relative valuation methods make them among the favorites of institutional an༺d retail investors.

澳洲幸运5官方开奖结果体彩网:Price-to-earnings, 澳洲幸运5官方开奖结果体彩网:price-to-sales, and 澳洲幸运5官方开奖结果体彩网:price-to-book values are typically analyzed when comparing the prices of various stocks based on a desired valuation standard. The 澳洲幸运5官方开奖结果体彩网:price-to-cash-flow multiple (P/CF) falls into the same category as these price metrics, as it evaluates the price of a company's stock relative to how much cash flow the fi🥀rm is generating.

Calculating the Price-to-Cash-Flow Ratio

P/CF multiples are calculated with an approach that's similar to those used in the other price-based metrics. The P, or price, is simply the current share price. In order to avoid volatility in the multiple, a 30- or 60-day 澳洲幸运5官方开奖结果体彩网:average price can be utilized to obtain a more stable value that is not skewed by ra🔯ndom market movements.

The CF, or cash flow, found in the denominator of the ratio, is obtained through a calc൲ulation of the trailing 12-month cash flows generated by the💫 firm, divided by the number of shares outstanding.

Let's assume that the average 30-day stock price of company ABC is $20—within the last 12 months $1 million of cash flow was generated and the firm has 200,000 shares outstanding. Calculating the 澳洲幸运5官方开奖结果体彩网:cash flow per share, a value of $5 is obtained ($1 million ÷ 200,000 shares). Following that, one would divide $20 by $5 to obtain the required 澳洲幸运5官方开奖结果体彩网:price multiple.

Also, note that the same result would be determined if the 澳洲幸运5官方开奖结果体彩网:market cap is divided by the operating cas♓h flow over the previous 12 months.

Different Types of Cash Flow

Cash flow can be calculated in several different wa💙ys. But when performing a comparative analysis between the relative values of similar firms, a consistent valuation appr🌄oach must be applied across the entire valuation process.

For example, one analyst might calculate cash flow as simply adding back non-cash expenses such as depreciation and amortization to net income. Alternatively, another analyst may look at the more comprehensive 澳洲幸运5官方开奖结果体彩网:free cash flow figure. And 💦a third approach would be to simply sum the operating, financing, and investing cash flows found within the cash flow statement.

While the free cash flow approach is the most time-intensive, it typically produces t🦋he most accurate results, which can be compared between companies. Free cash flows are calculate🌠d as follows:

FCF = [Earnings Before Interest Tax x (1 – Tax Rate) + Depreciation + Amortization – Change in Net 澳洲幸运5官方开奖结果体彩网:Working Capital – Capital Expenditures]

Most of these inputs can be quickly pulled from a company's financial statements. Regardless of the approach used, it must be consistent. When trying to evaluate a company, it always comes down to determining the value of the free cash flows and 澳洲幸运5官方开奖结果体彩网:discounting them to today.

Relative Value Analysis

Once the P/CF ratio is calculated, the initial result does not actually reveal anything of great significance to the analyst. Similar to the subsequent procedure for 澳洲幸运5官方开奖结果体彩网:relative value methodologies—which use the P/E, P/S, and P/BV 💝multiples—the calculated P൲/CF must be assessed based on comparable companies.

A P/CF of five does not actually reveal much useful information unless the industry and the firm's life stage are known. A low free-cash-flow price multiple may be unattractive for an established slow-growth insurance firm, yet present a solid buying opportunity for a small biotech startup.

Basically, to get a sense if a company is trading at a cheap price relative to its cash flows, a list of appropriate 澳洲幸运5官方开奖结果体彩网:comparables must form the comparison benchmark.

Advantages and Disadvantages of the P/CF Ratio

There are several advantages that the P/CF holds over other investment multiples. Most important—in contrast to earnings, sales, and book value—companies have a much harder time manipulating cash flow. While sales, and inevitably earnings, can be manipulated through such practices as 澳洲幸运5官方开奖结果体彩网:aggressive accounting, and the book value of assets falls victim to subject🎃ive estimates and depreciation methods, cash flow is simply cash flow. It is a concrete metric of how much cash a firm brings in within a given period.

Cash flow multiples also provide a more accurate picture of a company. Revenue, for example, can be extremely high, but a paltry gross margin would wipe away the positive benefits of high sales volume. Likewise, earnings multiples are often difficult to standardize due to variable 澳洲幸运5官方开奖结果体彩网:accounting practices across companies꧂. Studies regarding fundamental analysis have concluded that the P/CF ratio provides a reliable indication of long-term returns.

Despite its numerous advantages, the P/CF ratio has some minor pitfalls. As previously stated, the cash flow in the denominator can be calculated in several ways to reflect different types of cash flows. Free cash flow to equity holders, for example, is calculated differently than cash flow to stakeholders, which is different from a simple summation of the various cash flows on th♒e cash flow statement. In order to avoid any confusion, it is important to always specify the type of cash flow being applied to the metric.

Secondly, P/CF ratios neglect the impaဣct of non-cash components such as deferred revenue. Although this is often used as an argument against this multiple, non-cash items such as deferred revenue will eventually introduce a tangible or measurable cash component.

Finally, similar to all multiple valuation techniques, the P/CF ratio is a quick and dirty approach that s﷽hould be complemented with discounted cash flow procedures.

The Bottom Line

Analyzing the value of a stock based on cash flow is similar to determining whether a share is under- or overvalued based on ༺earnings. A high P/CF ratio i꧂ndicates that the specific firm is trading at a high price but is not generating enough cash flows to support the multiple. Sometimes this is OK, depending on the firm, industry, and its specific operations.

Smaller price ratios are generally preferred, as they may reveal a firm generat🦂ing ample cash flows that are not yet properly considered in the current share price.

Holding all factors constant, from an investment perspective, a smaller P/CF is preferred over a larger multiple. Nevertheless, like all fundamental ratios, one metric never tells the full story. The entire picture must be determined from multiple angles (ratios) to assess the 澳洲幸运5官方开奖结果体彩网:intrinsic value of an investment. The P/CF multipl🌳e is simply another tool that investors should add to their repertoire of valu𝔍e-searching techniques.