Price multiples are commonly used to determine the equity value of a company. The relative ease and simplicity of these relative valuation methods make them among the favorites of institutional and retail investors.
Price-to-earnings, price-to-sales, and price-to-book values are typically analyzed when comparing the prices of various stocks based on a desired valuation standard. The price-to-cash-flow multiple (P/CF) falls into the same category as the above price metrics, as it evaluates the price of a company's stock relative to how much cash flow the firm is generating.
Calculating the Price-to-Cash-Flow Ratio
P/CF multiples are calculated with a similar approach to what is 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 average price can be utilized to obtain a more stable value that is not skewed by random market movements.
The CF, or cash flow, found in the denominator of the ratio, is obtained through a calculation 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 cash flow per share, a value of $5 is obtained (or $1 million / 200,000 shares). Following that, one would divide $20 by $5 to obtain the required price multiple.
Source: Investopedia, Analyzing the Price-to-Cash-Flow Ratio, accessed 25 April 2024, <https://www.investopedia.com/articles/stocks/11/analyzing-price-to-cash-flow-ratio.asp>
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