• Price/Cashflow ratio could be a more reliable measure than Price/Earnings ratio
  • P/CF ratio excludes non-cash items, offering a clearer financial performance measure
  • Here are ASX stocks with some of the best P/CF ratios

 

When it comes to assessing a company’s worth, most investors are familiar with the Price Earnings (P/E) ratio.

But there’s another key metric that deserves attention: the Price/Cash Flow (or P/CF) ratio.

Unlike the P/E ratio, which compares a company’s stock price to its earnings per share, the P/CF ratio takes a different approach.

It assesses a company’s value by comparing the share price to its operating cash flow per share.

 

P/CF Ratio = Market Cap/Cash Flow from Operations

 

This distinction is important because it focuses on the actual cash generated by a company’s operations rather than its accounting earnings.

One of the key advantages of the P/CF ratio is its exclusion of non-cash elements like depreciation and amortisation.

By removing these factors, which can be subject to manipulation through accounting practices, the P/CF ratio offers a more accurate measure of a company’s true financial performance.

The Price-to-Cash Flow ratio thus provides a clearer insight into a company’s capacity to fulfil financial commitments and pursue growth prospects.

 

What’s considered a good P/CF ratio?

Generally speaking, a lower P/CF ratio suggests that the company generates strong cash flow relative to its stock price, indicating financial stability.

Depending on the industry, market’s consensus of a good P/CF ratio tends to be any number below 10.

The P/CF ratio can also serve as a valuation metric.

By comparing a company’s market value to its operating cash flow, investors can assess whether a stock is overvalued, undervalued, or fairly priced based on its cash-generating ability.

A lower P/CF ratio may indicate that the stock is undervalued, while a higher ratio may suggest overvaluation.

Furthermore, the P/CF ratio enables comparative analysis.

Investors can use this metric to compare companies within the same sector, helping them identify stocks with more attractive valuations relative to their cash flow performance.

A company’s cash flow from operations can be found in the cash flow statement released to the ASX.

Data on the P/CF ratio meanwhile can be found in places like the trading platform you use, like Commsec etc.

 

But beware of this

It’s important to approach the P/CF ratio with caution and deeper analysis.

Some industries inherently generate higher cash flows, which may appear to lower the P/CF ratios of companies within those sectors when viewed superficially.

For example, in the utilities sector, companies that provide essential services like water, gas, and electricity tend to enjoy high and steady cash flows.

Similarly, companies in the consumer staples sector, which sell everyday necessities such as food, beverages and personal care items, often experience high cash flows.

Healthcare companies, including pharmaceuticals, medical devices, and healthcare services providers, also tend to generate strong positive cash flows as demand for healthcare remains relatively stable.

Certain segments within the information technology sector, such as software and cloud services, can produce high cash flows, particularly tech companies that offer subscription-based services and software licences.

And in the real estate sector, companies involved in real estate investment trusts (REITs) often generate strong positive cash flows.

 

ASX stocks and their P/CF ratios

Here are some of the ASX stocks with the best (or low) P/CF ratios.

 

ASX Large Caps

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ASX Small Caps

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Now read: Price Earnings Ratio: How you should (or shouldn’t) use it to find undervalued stocks