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Definition: Price-To-Cash-Flow Ratio
Price-To-Cash-Flow Ratio is the measure of the stock prices of a particular company to the amount of money it makes. It is one of the price multiple which is mainly used to determine the equity value of any company.
The ratio as such doesn’t give much information, unless it is compared with the industry average and the stage of the company is known. By comparing with industry average, we can say that a particular stock of any company is undervalued or overvalued. Let’s see how it is calculated.
Price-to-Cash Flow Ratio = Price per share / (Cash flow / Shares outstanding)
The optimal value of this ratio depends on the industry sector and the stage in which the company is in currently. For example we cannot compare a new technological company and an old utility company with stable cash flows but little avenues for growth.
Operating cash flow is arrived at by adding non-cash expenses such as depreciation and amortization to net income. Some of the analysts use Price to free cash flow ratio. Free cash flow can be calculated by:
FCF = Earnings before Interest Tax * (1 – Tax Rate) + Depreciation + Amortization – Change in Net working capital – Capital Expenditures
This is one of the most preferred techniques for relative valuation of any company. Though, for proper analysis more price multiples should be used in addition to price to cash flow ratio like price to earnings or price to book value ratios.
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