Instead of Price Earning (P/E) Ratio many investment analysts prefer to look at price cash flow ratio. A Price to Cash Flow Ratio is measured as the company’s current stock price divided by its current annual cash flow per share.
Price/Cash Flow Ratio = Price Per Share / (Cash Flow / Shares Outstanding)
There are varieties of definitions of cash flow. In this context, the most famous measure is simply calculated as net income plus depreciation. Cash flow is usually reported in firm’s financial statement and labelled as cash flow from operations.
According to Investopedia,
A measure of the market’s expectations of a firm’s future financial health. Because this measure deals with cash flow, the effects of depreciation and other non-cash factors are removed. Similar to the price-earnings ratio, this measures provides an indication of relative value.
The difference between cash and earnings is often confusing largely because the way standard accounting practice defines net income. Essentially net income is measured as incomes minus expenses. Obviously this is logical. However not all are actual cash expenses. The most important exception is depreciation.
When a firm acquires a long-lived asset such as new factor facility, standard accounting practice does not deduct the cost of the factory at all once, even though it is actually paid for all at once. Instead the cost is deducted over time. These deductions do not represent actual cash payments, however. The actual cash payments occurred when the factory was purchased. Most analysts agree that in examining a company’s financial performance, cash flow can be more informative than the net income.
The stock for Company ABC is selling at Rs. 25 a share.
The total number of shares issued for the period is 10,000.
The company’s operating cash flow for the four most-recent quarters are Rs 30,000, Rs 50,000, Rs 60,000 and Rs70,000
Let us calculate its Price to cash flow ratio
The operating cash flow for the past 12 months = 30,000 + 50,000 + 60,000 + 70,000 = Rs 210,000
Cash flow per share = Rs 210,000 / 10,000 = Rs. 21
Price to Cash Flow = 25 / 21