Question

• Prompt: Price/cash flow ratio – Please write a paper about the price/cash flow ratio. Why has it become a popular measure of relative value during the recent past? What
  factors help explain a difference in this ratio for two firms?
• Requirements: 500 words

Answer 1

Answer:

Price/cash flow ratio- This is an indicator of stock valuation. It measures the value of stock's price relative to its operating cash flow per share. In the calculation of this ratio, operating cash flow is used which adds back non-cash expenses such as depreciation and amortization to the Net income. This ratio is used for the stocks of the companies that have positive cash flows but are not profitable because of large non cash expenses.

Formula: Price/cash flow ratio = Share price / Operating cash flow per share

How to calculate the ratio- In order to calculate the ratio past 30 days average stock price can be taken. The operating cash flow can be taken through a calculation of the trailing 12 months operating cash flow generated by the firm and divided by the number of shares outstanding.

What does it tell You- This ratio tells you how much a company generates relative to its stock price. It works well for the companies, having large non cash expenses. A low ratio implies that stock may be undervalued.

A better measure- Price to cash flow is more authentic than price to earning ratio because in price earning ratio, earnings can be manipulated with the help of depreciation but in Price/cash flow ratio, cash flows cannot be manipulated.

Example- ABC company has share price of $10 and operating cash flow is $100 million, it has $50 million shares of outstanding. Calculate Price/cash flow ratio?

Answer: Price/cash flow ratio = Share price / Operating cash flow per share

Operating Cash flow per share: 100 / 50 = $2

Price/cash flow ratio: 10/2 = 5

This indicates that company's shareholders are willing to pay $5 for every dollar of cash flow.