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Definition

Price-to-Free-Cash-Flow ratio is calculated as follows:

Price-to-Free-Cash-Flow = Share Price / Free Cash Flow per Share

Or

Price-to-Free-Cash-Flow = Market Cap / Free Cash Flow

Free Cash Flow is calculated as:

Free Cash Flow per Share

= (Cash Flow from Operations + Change in Property, Plant and Equipment).

= Net Income + Depreciation, Depletion and Amortization - Change in Net Working Capital - Capital Expenditure.

Explanation

Free Cash Flow is considered more important than earnings by value investors. The reason is because, in principle, only the net cash that can be taken from the business belongs to shareholders. This Free Cash Flow can be used to grow the business, reduce debt or return to shareholders in dividends or share buybacks.

In a DCF Calculation Free Cash Flow is used to determine the intrinsic value of companies.

Beaware

In real business, Free Cash Flow can be affected by the change in accounts receivable, accounts payable, management’s decision on expansion, etc. Therefore, investors should look at the Free Cash Flow over the longer term. Long-term average of Free Cash Flow is a more reliable indicator for real free cash flow.

Related Terms

P/S Ratio, P/B Ratio, P/E Ratio, Free Cash Flow

Financial Dictionary

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