The Price to Earnings ratio (or P/E) is probably the most common
ratio in determining whether a company is under or overvalued.
However, the Price to Cash Flow (or P/CF) is another great ratio to
do just that.
Cash, of course, is vital to a company's financial health in order
to finance operations, invest in the business, etc.
And cash can't really be manipulated on the Income Statement like
The reason why some like this measurement better than the P/E ratio
is because the net income of the Cash Flow portion rightly adds
depreciation and amortization back in, since these are not cash
Whereas the net income that goes into the Earnings portion of the
P/E ratio does not add these in, thus artificially reducing the
income and skewing the P/E ratio.
So many analysts prefer using the Price to Cash Flow metric to
judge a stock's value.
And just like the P/E ratio is calculated by dividing the Price by
its Earnings per share -- the Price to Cash Flow ratio is
calculated by dividing the Price by its Cash Flow per share.
Also like a P/E ratio, the lower the number, the better.
Currently, the average Price to Cash Flow (P/CF) for the stocks in
the S&P 500 is 14.05.
But just like the P/E ratio, a value of less than 15 to 20 is
generally considered good.
In my testing I have found that a P/CF between 0-10 produced the
best results (17.1% over the last 10 years (using a 1-week
rebalancing period). The second best results came with the range of
10-20 with a 10.2% gain. However, once you get over 30, the odds
point to a loss (-2.8%). And over 40, the odds of loss are even
greater at -6.9%.
By the way, if you add the Zacks Rank to that first range, the
results increase to 34.7%. Pretty awesome.
This being said though, I still also like comparing the stocks'
P/CF to its Industry, as different Industries will have different
numbers that are considered normal.
For example: for Computer-Software companies, the average
Price/Cash Flow is about 19.2, whereas for Telecom it's about 6.0.
The screen I'm running today is relatively simple:
Zacks Rank equals 1
(Only Strong Buys get thru.)
One Year Projected Growth Rate greater than or equal to
Average for the S&P 500
(Looking for above market growth rates.)
Current Cash Flow greater than or equal to 5 Year Average
(I want to see the company's cash position improving.)
Price to Cash Flow less than or equal to Median for its
(Want to see companies with valuations lower than the median for
their respective groups.)
There were 22 stocks that came thru this week's screen. Here are 5
(P/CF = 13.42)
(P/CF = 4.84)
(P/CF = 8.81)
(P/CF = 11.04)
(P/CF = 6.65)
Start looking for value stocks in new ways with this week's screen.
Sign up now for your free trial today and start picking better
stocks immediately. And with the backtesting feature, you can test
your ideas to see how you can improve your trading in both up
markets and down markets. Don't wait for the market to get better
before you decide to do better. Start learning how to be a better
trader today! You can do it.
Click here to sign up for a free trial to the
Research Wizard today.
Disclosure: Officers, directors and/or employees of Zacks
Investment Research may own or have sold short securities and/or
hold long and/or short positions in options that are mentioned in
this material. An affiliated investment advisory firm may own or
have sold short securities and/or hold long and/or short positions
in options that are mentioned in this material.
Disclosure: Performance information for Zacks' portfolios and
strategies are available at:
BROADRIDGE FINL (BR): Free Stock Analysis
US AIRWAYS GRP (LCC): Free Stock Analysis
MONTPELIER RE (MRH): Free Stock Analysis Report
NETFLIX INC (NFLX): Free Stock Analysis Report
PERICOM SEMICON (PSEM): Free Stock Analysis
To read this article on Zacks.com click here.