Price to free cash flow

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28th Jul '19 by The Phoenix

5 comments 1229 reads

Hi could someone explain to me the relevance of this stat in Stockreports It would appear that the lower the figure quoted the better if I have it correct a price to free cash flow figure of one would indicate that it would take 12 months for free cash flow to equal the current stock price.

I also get the impression that the free cash flow figure is more important than the earnings per share figure as its harder to manipulate ?

Any pointers welcome thanks.

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The Phoenix

Premium Member

5 comments

underscored

28th Jul '19

Free cashflow is harder to manipulate, but can be volatile.

Nick Ray

29th Jul '19

"Free cash flow" is a bit like "earnings which can be turned into cash" so P/FCF is similar to P/E.

For example comparing the quartiles of P/E and P/FCF in the UK market we get this:

Quartile	P/E	P/FCF
25%	11	13
50% (median)	16.5	21
75%	26	35

so P/FCF values are a little bit higher than P/E values in general. (Obviously it is when a stock has markedly different P/FCF compared with P/E that things get interesting).

However because P/FCF is a "value" metric it is a bit of a tricky call whether you want a low value (cheap but maybe for a good reason) or high value ("reassuringly" expensive).

Stocko also has "FCF/LT Assets"and "FCF 5y CAGR %" which are quality/growth metrics so the bigger the better without any qualification.

As I hinted above, I almost always use the "ranked" option in screens these days. So rather than type in explicit values for any of these metrics, I might choose (for example) Rank(P/FCF) between 20% and 80% or Rank("FCF/LT Assets") > 85%

timarr

29th Jul '19

Hi clarea

As a rule of thumb I treat P/FCF like P/E: so anything below 10 is cheap, anything above 20 is expensive - although Nick's point about using rankings is particularly pertinent when everything looks expensive.

Comparing the two ratios is a useful shortcut: if they're relatively similar then you have a business that turns a lot of earnings into cash, and isn't accruing lots of future revenue onto its books - which can happen for valid reasons, but can also be a serious red flag. Businesses with high levels of accruals tend to have more profit warnings - actual cash is real earnings, but accrued earnings may never happen.

Obviously that's only a starting point, but it's one of the things I look for. Any business that's got a FCF of over 75% of earnings is usually OK, below that I'd want to dig more.

Occasionally FCF is higher than earnings - there are a variety of reasons why this can occur - amortisation of assets is a common one - it's a non-cash drag on earnings, but has no impact on cash flow. Always has to be analysed to see what's going on.

Obviously there are businesses where FCF may not give a full picture - generally things like banks (where net interest is kind of the point) and resources companies (where a lot of the future value is in the ground). Oh, and blue sky companies where the value is in the heads of the investors. But I don't invest in any of those anyway :)

timarr

The Phoenix

29th Jul '19

Thanks all for the replies

Merlotman

29th Jul '19

Clarea

Like other commentors here I attach more importance to FCF PS than I do to EPS PS. However due to volatility particularly relating to working capital movements I look at FCF based ratios over a 5 year period rather than the 1 year stock provides

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About the Author

The Phoenix

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