Using Price-to-Cash Flow to Find Value

By Kevin Matras
On 1:00 am EST, Tuesday November 10, 2009

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, especially nowadays, in order to finance operations, invest in the business, etc.

And cash can't really be manipulated on the Income Statement like earnings can.

The reason why some people like this measurement better than the P/E ratio is that the net income of the Cash Flow portion rightly adds back in depreciation and amortization, since these are not cash expenditures.

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 9.6. For the 12-month forward P/E ratio, it's 15.3.

But just like the P/E ratio, a value of less than 15 to 20 is generally considered good.

But make sure you compare the stock's P/CF to its Industry, since different Industries will have different numbers that are considered normal.

For example: the average Price/Cash Flow for Gold Mining companies is about 30, whereas it's about 3 for Telecom.

Screen

The screen I'm running today is relatively simple:

Zacks Rank = 1

(Only Strong Buys get thru.)
One Year Projected Growth Rate >= Average for the S&P 500
(Looking for above-market growth rates.)
Current Cash Flow >= 5 Year Average Cash Flow
(I want to see the Company's cash position improving.)
Price to Cash Flow less than or equal to Median for its Industry
(I want to see Companies with valuations lower than the median for their respective groups.)

There were 30 stocks that came thru this week's screen. Here are 5 of them:

BARE Bare Escentuals, Inc.

CMN Cantel Medical Corp.

HS HealthSpring, Inc.

TTC Toro Company

VIA.B Viacom Inc.

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: http://www.zacks.com/performance.

BARE ESCENTUALS (BARE): Free Stock Analysis Report

CANTEL MED CORP (CMN): Free Stock Analysis Report

HEALTHSPRING IN (HS): Free Stock Analysis Report

TORO CO (TTC): Free Stock Analysis Report

VIACOM INC-B (VIA.B): Free Stock Analysis Report

Zacks Investment Research