Price-To-Cash-Flow Ratio

  

Categories: Company Valuation

See: Cash Flow. See: EBITDA.

So you're buying a stock for $28 a share. This year, it has $2 in cash flow, or EBITDA. See: Free Cash Flow so you know the difference. FCF is kind of a more "net number" than is EBITDA...more "pure" when it comes to actual cash.

Why does it even matter? Well, if you're paying $28 for $2 in cash returns this year, you're paying 14 times that number, or a cash on cash return of something like 1/14, or about 7%. Good? Bad? Ugly? Unclear. If the $2 is going to $3 next year and $4 the next, then great; if it's going negative, then yeah, not so good. It's just another metric investors use to figure out whether they're buying a stock on Macy's White Flower Day Sale...or they're at a Persian Rug Bazaar with a bunch of "friends" selling them...stuff.

Related or Semi-related Video

Finance: What is cash flow v earnings?17 Views

00:00

Finance allah shmoop what is cash flow versus earnings Okay

00:08

you think profits or profits right Well not unless you

00:11

spell it P r o p h e t s

00:14

Ask a gandhi or jeff bezos about that All right

00:17

Well in the land of accounting there are aptly named

00:20

accounting profits and there are also cash profits and the

00:25

two of them are often very different Accounting laws skew

00:29

things when it comes to assessing riel cash profits Here's

00:33

out the ceo and founder of give a dog a

00:35

drone A company that specializes in engineering remote control toys

00:40

for your pets built a drone stamping factory for one

00:43

hundred million dollars knowing that it will be worth twenty

00:46

million dollars in scrap value in just four years Well

00:49

he'll sell at that point and possibly upgrade if demand

00:52

for puppy and kitty tech is still high will drone

00:56

sales or steady producing cash profits of fifty million bucks

00:59

a year each year into the foreseeable future but stated

01:03

earnings and cash flows here are very different In the

01:07

first year when the factory was built the company lost

01:10

big cash money because it had to write one hundred

01:13

Million dollar check to the builder of the factory Yes

01:16

it made fifty million in profits but that year it

01:20

lost fifty million dollars in cash Luckily it had no

01:24

debt and it had one hundred twenty five million dollars

01:27

in the bank Well that bank account went down to

01:29

just twenty five million when they wrote one hundred million

01:32

dollar check But it gradually filled back up to seventy

01:35

five million by the time that year was done fifty

01:38

million of profits and that fifty million in cash Yeah

01:41

that that helps that floated right back in there Okay

01:44

so the cash that year was volatile It was a

01:46

hundred twenty five million to start But then i went

01:48

down to twenty five million after the factory purchase than

01:50

end up a year later with fifty million added to

01:52

their coffers and gas profits from operation leaving them with

01:57

seventy five million bucks in the bank got all that

01:59

All right So here's where the difference hits between accounting

02:02

profits perspective and a cash flow perspective on the notion

02:06

of profit Simply put it isn't fair for the company

02:09

Tohave a view that the one hundred million dollars factory

02:13

as an expense should all hit the profits line all

02:17

in one year as if they bore the burden of

02:19

all that factory cost in one year and then showing

02:22

it is being worthless in years Two three four and

02:26

maybe beyond In fact the company doing proper accounting depreciates

02:31

that factory in value to the tune of twenty million

02:34

dollars a year for for four years until it will

02:37

then sell it for scrap for twenty million bucks So

02:40

that hit to the company in the first year should

02:42

be twenty million dollars in value not one hundred million

02:46

in cash That's an accounting change of assessing twenty million

02:50

in expenses not one hundred million how's that work well

02:53

the decline in value of that hundred million dollars takes

02:56

five years And it looks like this But in your

02:58

won the company loses one hundred million dollars in cash

03:01

but gains a factory Confused Good Okay well let's zoom

03:04

forward to your floor The company again made fifty million

03:08

dollars in cash profits but it will show earnings of

03:10

only thirty million Why Well because proper accounting using straight

03:14

lined appreciation of that hundred million dollar factory properly shows

03:18

the company depreciating it's value another twenty million dollars against

03:22

its cash profitability So what A thirty percent tax rate

03:25

company pays taxes on thirty million of profits or a

03:28

tax bill of nine million bucks It's accounting earnings are

03:31

actually twenty one million dollars but it will have produced

03:34

cash or cash flow of fifty million dollars minus the

03:38

nine million in taxes or forty one million in cash

03:42

profits I either Cash flow is almost double the reported

03:47

accounting profits Now with all that profit our company can

03:50

finally start mass producing kitty copters Yeah yeah we're naming 00:03:55.308 --> [endTime] this cat todd

Up Next

Finance: What is free cash flow?
13 Views

What is free cash flow? Free cash flow is the leftover cash a company has on hand from revenues after capital expenses are deducted. It is consider...

Find other enlightening terms in Shmoop Finance Genius Bar(f)