What is Price-to-cash flow ratio? How useful is this ratio?

• To measure whether a company’s share price is high or low in the context of its cash flow.
• Useful as it indicates the company’s market value plus enabling competitor analysis among companies.
• Important as this ratio can also indicate the future financial health of a company

Simple illustration:

Interpretation:

• The lower the price-to-cash flow ratio means the more the company may be undervalued which poses good opportunity for investment.

Salient points to note:

• This business ratio is useful as it does not need to go through the process of using net income less depreciation and amortization charge
• The disadvantages is that cash flow is not static and different industries are associate with different price-to-cash flow level
• Note that to be comparable the price-to-cash flow ratio should be used in companies which sells similar products and services
• A related ratio is the price-to-free cash flow which is cash that is available to benefit the shareholders and after deducting capital expenditures from operating cash flow. This price-to-free cash flow ratio shows how much investors must pay for each $1 of free cash flow)