What is the price of free cash flow?
Free cash flow price is a measure of equity used to compare the market price per share of a company to its amount per share of free cash flow (FCF). This measure is very similar to the measurement of the price in cash flow, but is considered a more accurate measure, because it uses free cash flow, which subtracts capital expenditure (CAPEX) from the cash flow d total operation of a business, thus reflecting the actual free cash flow available to finance non-asset-related growth. Companies use this metric when they need to broaden their asset base either to grow their business, or simply to maintain acceptable levels of free cash flow.
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Key points to remember
- Price versus free cash flow is an equity measure that indicates a company’s ability to generate additional revenue. It is calculated by dividing its market capitalization by the value of free cash flow.
- A lower price / free cash flow ratio indicates that the business is undervalued and that its inventory is relatively cheap. A higher price / free cash flow ratio indicates an overvalued company.
Understand the price and free cash flow
The free cash flow of a company is important because it is a basic indicator of its ability to generate additional income, which is a crucial element in the valuation of stocks.
The price measure against free cash flow is calculated as follows:
Price at free cash flow = market capitalization value / total amount of free cash flow
For example, a business with $ 100 million in total operating cash flow and $ 50 million in capital expenditures has total free cash flow of $ 50 million. If the company’s market capitalization is $ 1 billion, the company’s stock trades at 20 times free cash flow – $ 1 billion / $ 50 million.
Understanding free cash flow
How Investors Use Price To Free Measure Cash Flow
Since the price of free cash flow is a measure of value, lower numbers generally indicate that a business is undervalued and that its inventory is relatively cheap relative to its free cash flow. Conversely, a higher price compared to free cash flow figures may indicate that the company’s shares are relatively overvalued compared to its free cash flow. Therefore, value investors prefer companies with low or decreasing prices for free cash flow values that indicate high or increasing free cash flow totals and relatively low stock prices. They tend to avoid companies whose high prices for free cash flow indicate that the company’s share price is relatively high compared to its free cash flows. In short, the lower the price of free cash flow, the more a company’s stock is considered to be a better deal or value.
As with any measure of equity, it is very useful to compare the price / free cash flow of a company to that of other similar companies in the same sector. However, the measure of price relative to free cash flow can also be viewed over the long term to see if the company’s cash flow for share price value generally improves or worsens.
The price / free cash flow ratio can be affected by companies that manipulate the state of their free cash flow on financial statements, by doing things such as retaining cash by deferring inventory purchases until the end of the period covered by the financial statements.