Price-to-Free-Cash-Flow Ratio
IntermediateThe price-to-free-cash-flow ratio compares a company's market capitalization with its free cash flow, showing how much investors are paying for each unit of cash available after the business has funded its operations and capital investment.
Free cash flow is operating cash flow minus capital expenditure. It represents cash that could be used to pay dividends, buy back shares, reduce debt or make acquisitions. The price-to-free-cash-flow ratio divides market capitalization by this figure.
For example, a company with a market capitalization of 2 billion and free cash flow of 125 million has a price-to-free-cash-flow ratio of 16.
Many investors regard free cash flow as the most meaningful measure of what a business produces for its owners, because it accounts for the spending needed to maintain and grow the business. A company with high earnings but heavy capital spending may produce little free cash flow, which this ratio would reveal.
A low ratio can indicate good value. The inverse of the ratio, free cash flow divided by market capitalization, is called the free cash flow yield. In this example, it is 6.25%.
Free cash flow can vary a lot from year to year, especially when companies make large one-off investments, so analysts often look at averages over several years.
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