What it means
Profit figures can be shaped by accounting choices such as depreciation (spreading the cost of an asset over its life) and the timing of revenue. Cash flow is harder to manipulate because it tracks the money actually moving in and out of the business.
The price to cash flow ratio uses that cash figure to judge how expensive a share is. Analysts normally use operating cash flow, the cash generated by the core business before investment and financing.
The ratio can be calculated per share, as share price divided by cash flow per share, or for the whole company, as market capitalisation (total value of all shares) divided by operating cash flow. Both approaches give the same answer.
The ratio is useful for companies with large non-cash charges, where earnings look low but cash generation is healthy. Capital-heavy sectors such as telecoms, shipping and manufacturing are common examples.
It is also a handy cross-check against the price to earnings ratio, because a big gap between the two invites a question about earnings quality. Interpreting the number needs care.
A low ratio may mean a bargain, or it may mean the market expects cash flow to fall. Comparing a company with its own history and with similar firms in the same industry is far more meaningful than comparing across industries.
A common variant uses free cash flow, which deducts capital spending from operating cash flow. That version, often called price to free cash flow, is stricter because it shows what is left for shareholders after the business has paid to maintain and grow its assets.
Always check which cash flow measure a quoted ratio is using. Timing matters when using the ratio.
Cash flow can swing from year to year because of working capital movements, such as a large customer paying early, so many analysts use an average of several years to smooth out the noise.
In practice
Real-world examples
Example 1
An analyst compares two shipping companies. One trades at 6 times cash flow and the other at 11 times. She investigates why and finds the cheaper one has older vessels and rising maintenance needs.
Example 2
A retail chain reports modest earnings because of heavy depreciation on new stores. An investor sees a price to cash flow ratio of 7, well below the sector average of 10, and concludes the shares may be undervalued.
Example 3
A finance director preparing for a share placement benchmarks the company against peers. The ratio of 9 sits in the middle of the group, which supports pricing the new shares close to the market price.
Think of it
Price-to-cash flow shows what you pay for each dollar of actual cash the company generates from operations.
Formula
Calculation
Price to cash flow = market capitalisation / operating cash flow
Suppose a company has 10,000,000 shares trading at $40, so its market capitalisation is 10,000,000 x 40 = $400,000,000. Operating cash flow for the year is $50,000,000, which is $5.00 per share. The ratio is 400,000,000 / 50,000,000 = 8, or on a per-share basis 40 / 5 = 8. Investors are paying $8 for each $1 of annual operating cash flow.Case study
Seen in the real world
Ironvale Industrial is an illustrative, fictional manufacturer whose shares looked expensive at 25 times earnings. A fund analyst noticed that depreciation on new machinery was depressing profit by $30,000,000 a year, while operating cash flow was $90,000,000 against a market value of $720,000,000.
The price to cash flow ratio was 720,000,000 / 90,000,000 = 8, comparable to cheaper peers. The analyst then checked capital spending and found it was running at nearly the same level as operating cash flow, so the free cash flow ratio would have been far higher. The illustrative conclusion was that the shares were fairly priced, and the cash flow lens had told only half the story.
The fund ended up holding a small position rather than a large one. A year later, when the company cut its capital spending, free cash flow rose and the shares re-rated upwards. The analyst noted in the file that the illustrative company had been fairly priced on the evidence available at the time.
Watch out
Common mistakes
- Using net income instead of cash flow in the denominator, which turns the ratio into the price to earnings ratio.
- Comparing companies in different industries, when cash flow patterns and capital needs differ widely.
- Treating a low ratio as proof of a bargain without asking why the market is paying so little for the cash.
Questions
People also ask
Which cash flow should be used?
Most analysts use operating cash flow, though some prefer free cash flow, and the ratio should state which one it uses.
Is a lower price to cash flow ratio always better?
Not always, because a low figure can reflect expected decline, so it should be read alongside growth and risk.
Can the ratio be negative?
Yes, if operating cash flow is negative, but the result is not meaningful for valuation.
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