Valuation indicators (7/9)

The price/free cash flow ratio

This ratio is calculated by dividing the stock price by the annual free cash flow per share, i.e. operating cash flow minus capital expenditures. We also sometimes find the price/cash flow ratio which is quite similar, although less reliable. As theThe first subtracts capital expenditures from cash flow, in effect giving a picture of the cash flow available to generate non-asset related growth.

Cash flow gives a good overview of the company and its ability to generate money in the long term. The big advantage of cash over profits is that we remove from the equation everything that does not relate to real cash flow, such as depreciation and amortization. Thanks to this, the price / free cash flow ratio is often considered to be the indicator least subject to accounting shenanigans. However, it is not completely immune to them. A company can indeed, for example, defer the payment of its invoices to increase its cash reserves.

The price/free cash flow ratio is the least known of those presented here. For that reason alone, I like it a lot. It also has the advantage of working for companies of all sizes. If with the book value we are in the Graham domain, with the free cash flow we are rather in the school of Warren Buffett, whose performance is also no longer to be demonstrated. The price / free cash flow ratio is also one of those that works best according to the various studies. It is often on the 2nd place on the podium, sometimes on the first.

I particularly like companies that have price/free cash flow ratios below 10.