Get Even More Visitors To Your Blog, Upgrade To A Business Listing >>

Price to Cash Flow Ratio | Formula | Examples | P/CF Valuation

Price to Cash Flow Ratio – Let us have a look at  PE Ratio of Chevron.

Price to Cash Flow Ratio

Currently, PE ratio of Chevron is at 149.88x. What do you think about Chevron’s valuation? A definite SELL? However, most of the analyst’s have given Chevron either a Strong Buy, or Buy rating. None of the analysts actually gave Chevron a SELL rating. Are they crazy?

Why did they give BUY ratings to Chevron? 

Chevron Buy Sell Recommendation

source: Yahoo Finance

Of course, these analysts are looking at ratios beyond Price to Earnings ratio and in Oil & Gas sector, other valuation multiples like EV/boe (Enterprise value to barrels of oil equivalent), EV/EBITDA and Price to Cash Flows become rather important.

From the graph above, we note that Chevron’s Price to Cash flows is at around 16.01x.

In this article, we will look at how the price to cash flows is useful in valuations.

  • What is Price to Cash Flow Ratio?
  • Price to Cash Flow Ratio – Formula
  • Interpretation of Price to Cash Flow Ratio
  • Price to Cash Flow Ratio – Basic Examples
  • Practical Example – Calculate Price to Cash Flow For Chevron
  • Oil & Gas Companies – Using P/CF to compare
  • Oil E&P Companies – Price To Cash Flows
  • Software Application – Price to Cash Flows
  • Utilities Sector – Price to Cash Flows
  • Limitations of Price to Cash Flow Ratio
  • In the final analysis

What is Price to Cash Flow Ratio?

One of the most important investment valuation ratios is Price to Cash Flow Ratio. Many financial experts considered this ratio as a more accurate measure of judging the attractiveness of an investment than price to earnings ratio.

There is a simple reason behind that. In case of price to Cash Flow Ratio, we consider the cash flow from operations which is the exact measure of how much cash came in and went out from core operations. Unlike cash flow, earnings can be easily manipulated because earnings (net income) easily get affected by depreciation and other non-cash factors.

Chevron Cash Flow from Operations

source: Chevron SEC Filings

We note from Chevron’s Cash flow from operations that Depreciation, Depletion, and Amortization numbers were very high. In fact, in 2015, it was higher than the overall Cash flow from Operations.

Through this price to cash flow ratio, you would be able to compare the cash flow per share with the price per share which will give you an idea about how much value you would get out of paying the kind of price you are going to pay.

If you want to invest into a company or a project, price to cash flow ratio is one of the first ones you should consider computing.

Price to Cash Flow Ratio – Formula

To get a thorough idea about price to cash flow ratio, we need to look at two separate ratios. Understanding these two ratios will help us figure out how to compute price to cash flow ratio for an investment.

Let’s look at the price to cash flow ratio first –

Price to Cash Flow = Share Price / Cash Flow per share

This ratio is super useful for investors as they can understand whether the company is over-valued or under-valued by using this ratio.

However, to find out this ratio we need to compute “cash flow per share”.

To calculate “cash flow per share”, we need two things. First, we need to know the “operating cash flow” which we will be able to see in the cash flow statement of the company for that period. Second, we need to know the number of “outstanding shares”.

So to calculate, the “cash flow per share”, we would do the following –

Cash flow per share = Operating Cash Flow / Outstanding Shares

Once we know the cash flow per share, we would be able to compute price to cash flow ratio very easily.

Interpretation of Price to Cash Flow Ratio

Many investors get busy in computing price to earnings ratio. But if you look at the price t earnings ratio, you would see that many companies can manipulate it to attract more investors. For example, as there are many non-cash factors affecting the “net income”, companies which want to manipulate the “net income” can increase or decrease the non-cash factors. Thus, price to earnings ratio is not always able to provide an accurate picture of a company or of a new investment.

However, when we look at the cash flow, it changes the game completely. In cash flow statement, no non-cash factors would be included. Thus, there is no way one can manipulate the net cash flow at the end of the period. So if we can compute the “operating cash flow” using the cash flow statement and divide it by the number of “outstanding shares”, then we will get a concrete idea about how much cash flow we can generate per share. Then we can compare the same with the price per share to conclude whether the investment is a good one or not.

If we try to find an optimal level of ratio, then we need to look at a particular sector. For example, if we look at a new technology start-up, its growth would be much faster resulting in a higher price to cash flow ratio; whereas, if we look at a utility company which is operating for decades, price to cash flow ratio would be much lower. In case of a technology start-up, as its growth is tremendous, the investors would put more valuation to it than the utility company which has stable cash flow but fewer opportunities for growth.

Price to Cash Flow Ratio – Basic Examples

We will look at few examples so that we can understand price to cash flow ratio from all angels.

Price to Cash Flow – Example # 1

The G Corporation has the following information. Use the information below to find out price to cash flow ratio.

Details In US $
Price per share 10/share
Cash Flow per share 4/share

From the example, we can directly compute price to cash flow ratio.

Details In US $
Price per share (A) 10/share
Cash Flow per share (B) 4/share
Price to Cash Flow  Ratio (A/B) 2.5

Depending on which sector G Corporation belongs, we can compare the price to cash flow ratio and find out whether it is a good number or not.

Price to Cash Flow – Example # 2

MNC Company has provided the following information –

Details In US $
Price per share 12/share
Operating Cash Flow 600,000
Outstanding Shares 500,000

Compute Price to Cash Flow Ratio.

In the above, example, we have two things to compute. First, we need to compute the cash flow per share and then the price to cash flow ratio.

Here’s the computation of cash flow per share –

Details In US $
Operating Cash Flow (1) 600,000
Outstanding Shares (2) 500,000
Cash Flow per share (1/2) 1.20/share

Now we can compute the price to cash flow ratio –

Details In US $
Price per share (A) 12/share
Cash Flow per share (B) 1.20/share
Price to Cash Flow  Ratio (A/B) 10

Again, the similar thing is applicable in this regard as well. Depending on the sector this company belongs to, we need to compare the price to cash flow ratio and find out whether it’s a good number or not.

Let’s take a complex example to find out price to cash flow ratio.

Price to Cash Flow – Example # 3

We have been given the following information by ABC Company –

Details In US $
Price per share 12/share
Outstanding Shares 30,000
Net Income 70,000
Loss on Sale of Property 2,000
Decrease in Accounts Receivables 1,000
Increase in Inventories 2,000
Increase in Accrued Interest Payable 700
Increase in Account Payables 1,000
Deferred Taxes 500
Depreciation & amortization 3,000

Compute the Operating Cash Flow, Cash Flow per share and also Price to Cash Flow ratio.

From the above example, first, we need to compute the operating cash flow –

Details In US $
Net Income 70,000
Adjustments:
Depreciation & amortization 3,000
Deferred Taxes 500
Decrease in Accounts Receivables 1,000
Increase in Inventories (2,000)
Increase in Accrued Interest Payable 700
Increase in Account Payables 1,000
Loss on Sale of Property 2,000
Net Cash Flow from Operating Activities 76,200

So now we know that the operating cash flow is US $76,200.

We also know the number of outstanding shares. So, it would be easier to compute cash flow per share –

Details In US $
Operating Cash Flow (1) 76,200
Outstanding Shares (2) 30,000
Cash Flow per share (1/2) 2.54/share

Now we would be able to compute price to cash flow ratio with ease –

Details In US $
Price per share (A) 12/share
Cash Flow per share (B) 2.54/share
Price to Cash Flow  Ratio (A/B) 4.72

So the price to cash flow ratio is 4.72. Depending on the sector ABC Company belongs to, we can compare and find out whether 4.72 is a good enough number in regards to price to cash flow ratio or not.

Practical Example – Calculate Price to Cash Flow For Chevron

Let us now calculate Chevron’s Price to Cash Flow Ratio.Chevron Cash Flow from Operations

Current Price = $115.60

Chevron Price to Cash Flow – 2013

  • Cash flow from Operations (2013) = $35,002 million
  • Number of Shares in 2013 = 1917 million
  • Cash Flow Per Share (2013) = 18.25
  • Price to Cash Flow (2013) = 115.60/18.25 = 6.33x

Chevron Price to Cash Flow – 2014

  • Cash flow from Operations (2014) = $31,475 million
  • Number of Shares in 2014 = 1884 million
  • Cash Flow Per Share (2014) = 16.70
  • Price to Cash Flow (2014) = 115.60/16.70 = 6.91x

Chevron Price to Cash Flow – 2015

  • Cash flow from Operations (2015) = $19,456 million
  • Number of Shares in 2015 = 1886 million
  • Cash Flow Per Share (2015) = 10.31
  • Price to Cash Flow (2015) = 115.60/10.31 = 11.20x

Please note that the price to cash flow that we earlier saw for Chevron (16.01x) is the trailing twelve month Price to Cash Flow.

Oil & Gas Companies – Using P/CF to compare

Now that we have a fair understanding of PCF ratio, let us now compare Oil & Gas companies – Exxon, Chevron and BP PCF ratio.

We note that for all three companies, Price to Cash flow ratio has been rising for the past 2-3 years.

Why do you think is this so?

Oil & Gas Companies - Price to Cash Flow Ratios

source: ycharts

There has been a slowdown in commodities (Oil) since 2013-2014. Oil prices directly affect their cash flows. Due to lower Oil prices, these companies saw a significant decline in their cash flow from operations.

Oil & Gas Companies - Declining Cash Flow from Operations v1

source: ycharts

With this reduced cash flow from operations in the recent quarters, Price to Cash Flow ratio for these companies who an upward trend (higher the P/CF ratio, expensive the firm is).

Oil E&P Companies – Price To Cash Flows

Price to Cash Flow is one of the most important tool to value Oil & Gas companies. This is because the best way to measure Oil companies performance is to look at its Core Cash Flows. These companies require large asset base and tend to accumulate high levels of debt to finance capital assets. Increased debt levels mean increased interest and debt repayments. Tracking these core cash flows provides us key insighs to company’s ability to service these debts. (DSCR).

On the other hand, Net income (Net profit) is not a cash measure and can remain steady (or show an increasing trend).  However, if cash flows are declining, then it is a clear indication that company may find it difficult to make its debt repayments.

The table below provides us with Price to Cash Flow ratios (TTM) of top Oil Exploration and Production companies.

S. No Name Market Cap ($ mn) Price to Cash Flow (TTM)
1 ConocoPhillips                                         61,778 13.62x
2 EOG Resources                                         60,638 26.52x
3 CNOOC                                         57,131 4.60x
4 Occidental Petroleum                                         52,523 15.29x
5 Anadarko Petroleum                                         39,224 16.81x
6 Canadian Natural                                         33,487 11.37x
7 Pioneer Natural Resources                                         31,220 20.90x
8 Mitsui & Co                                         24,808 8.43x
9 Devon Energy                                         24,133 9.67x
10 Apache                                         23,608 11.09x
Average Price / Cash Flow 13.83x

as of January 20, 2017

Some important points to note here –

  • Average Price to Cash flow ratio of these top companies is around 13.83x
  • EOG Resources and Pioneer Natural Resources are the two outliers in this sector with P/CF ratio of 26.52x and 20.90, respectively.
  • If we remove these outliers, then the Average PCF ratio comes out to be 11.36x

Software Application – Price to Cash Flows

Unlike Oil & Gas companies, Software Application companies have an asset-light model. Instead of tangible assets, we find that its assets consist of intangible assets (patents, IPs, copyrights). Another characteristic of Software companies is that they don’t rely heavily on debt (like the Oil & Gas companies). Due to this, Software companies are not valued on the basis of P/CF ratio.

Instead, analyst use multiples like PE, PEG, EV/EBIT, EV/Customer etc to value such companies.

(also, have a look at Enterprise value vs Equity Value multiples)

The table below provides us with Price to Cash Flow ratios (TTM) of top Software Application Companies.

S. No Name Market Cap ($ mn) Price to Cash Flow (TTM)
1 SAP                                       110,117 23.98x
2 Adobe Systems                                         54,286 25.15x
3 Salesforce.com                                         52,650 27.75x
4 Intuit                                         29,761 21.85x
5 Dassault Systemes                                         19,384 28.06x
6 Autodesk                                         17,800 55.20x
7 Check Point Software Tech                                         16,850 18.09x
8 Symantec                                         16,558  –
9 Workday                                         16,490 47.60x
10 ServiceNow                                         13,728 102.65x
Average Price / Cash Flow 38.93x

source: ycharts

Some important points to note here –

  • Average Price to Cash flow ratio of these top companies is around 38.93x. This is very high.
  • Autodesk, Workday and ServiceNow are the three outliers in Software application category with P/CF multiple of 55.20x, 47.60x and 102.65x, respectively.

Utilities – Price to Cash Flows

Key characteristic of Utilities companies is that they are Capital Intensive Model with steady cash flows, and high levels of debt in balance sheet. As a result, we can apply P/CF to value Utilities companies.

The table below provides us with Price to Cash Flow ratios (TTM) of top Utilities Companies sorted by Market Capitalization

S. No Name Market Cap ($ mn) Price to Cash Flow (TTM)
1 NextEra Energy                                         55,736 8.02x
2 Duke Energy                                         53,131 7.74x
3 Southern                                         48,069 8.45x
4 Dominion Resources                                         47,395 10.46x
5 National Grid                                         45,950 6.47x
6 Exelon                                         45,333 4.88x
7 ENEL S.p.A                                         44,733 3.42x
8 Exelon                                         32,998 3.55x
9 Dominion Resources                                         31,494 6.95x
10 PG&E                                         30,896 7.50x
Average Price / Cash Flow 6.74x

source: ycharts

  • Average Price to Cash flow ratio of these top Utilities companies is around 6.74x

Limitations of Price to Cash Flow Ratio

There is only one limitation to this ratio. It also has one loop holes and that is this – it doesn’t take capital expenditure into account.

If you want to know a rigorous measure of this ratio, we need to extend beyond price to cash flow ratio (P/CF) and we need to calculate free cash flow and compare it with the price per share.

Free cash flow is amount of cash flow which is available to a business after deducting the capital expenditure. Computing Free Cash Flow may sound complicated. But here’s the deal

All we need to do is to go back to the income statement of the company and pick net income. Then we need to add back depreciation and amortization as they are non-cash charges. Next we will take into account any changes in the working capital and thus, we would get the operating cash flow. From operating cash flow, if we deduct the capital expenditure (new machinery), then we would get free cash flow.

To understand this, we can take an example and illustrate the same.

An Ice Cream Company has operating cash flow of US $100,000. And now the company has decided to buy a new refrigerator as the demand of their ice-creams have increased. Thus, they have bought a refrigerator of US $30,000. So what would be the free cash flow of this ice cream company? It would be = US $(100,000 – 30,000) = US $70,000. With the free cash flow of US $70,000, the ice cream company now will be able to pay off its debt (if any) and would be able to bear other expenses.

So finally what is more rigorous, accurate ratio? It is the price to free cash flow ratio.

Price to Free Cash Flow = Share price / Free Cash Flow per share

All we need to do is to divide the free cash flow by the outstanding shares of the company. And that will give more accurate picture of whether to invest into a company or not.

In the final analysis

It can be easily said that price to cash flow ratio is very useful for investors. It gives an almost accurate picture of how good an investment is. And the price to cash flow ratio is useful because there is little or no chance of manipulation in the cash flow.

If as an investor, you would like to invest into a new project or a new start-up, use this ratio as the measuring grid. You can also use price to earnings ratio. But the price to cash flow ratio is, by all means, a better measuring grid.

The post Price to Cash Flow Ratio | Formula | Examples | P/CF Valuation appeared first on Free Investment Banking Tutorials | WallStreetMojo.



This post first appeared on Free Investment Banking Tutorials |WallStreetMojo, please read the originial post: here

Share the post

Price to Cash Flow Ratio | Formula | Examples | P/CF Valuation

×

Subscribe to Free Investment Banking Tutorials |wallstreetmojo

Get updates delivered right to your inbox!

Thank you for your subscription

×