Price to Cash flow, what's good, what's bad, what does it mean?

[TheMotorcycleBoy]

We are looking at other shares we'd like to think of buying. And again, trying to think of reasonable prices. I'm just parking "discounted dividend" models for now, and looking at what I think are referred to as "Price multiples".

By the way I've also read/heard of the PYAD concept, and whilst I'm a bit dubious about whether we will be able to find brilliant firms at knock down prices, I do think that the concept is pretty sound, and I'd like to try to really think more about valuing a share before pressing the buy button.

So we had a look at a few shares, those being Lloyds (LLOY), Royal Dutch Shell (RDSB) and Kingfisher (KGF).

This is a quick copy and paste of some figures taken just now from the Morningstar:

RDSB
====
Price/Earnings 	 14.6
Price/Book 	 1.4
Price/Sales 	 0.8
Price/Cash Flow  8.5
Dividend Yield % 5.3

LLOY
====
Price/Earnings 	 11.9
Price/Book 	 0.9
Price/Sales 	 1.4
Price/Cash Flow  7.9
Dividend Yield % 5.1

KGF
===
Price/Earnings 	 13.9
Price/Book 	 0.8
Price/Sales 	 0.5
Price/Cash Flow 17.2				
Dividend Yield % 4.2

So as we can see, they are chosen from quite different sectors: Energy, Banking, Consumer DIY.

What does Price/Cash flow mean? Is it really just like a super charged version of P/E? That is, earnings with tax+interest+depreciation-capex as the denominator instead of just earnings.

So in summary is this comparison, with all else being equal, just saying "if you buy KGF you are just paying about 2x as much for the same free cash flow as for LLOY and RDSB?

M&M

[TheMotorcycleBoy]

Well I managed to answer my own question. Since it's still quite early, I'll give you the longish version, hope you have a coffee nearby. I was reading the current copy of IC last night, in particular, an article about FCF and FCF growth, by Phil Oakley the author of this book. Cutting to the chase he was comparing various "High-quality UK shares FCF yield and yield on cost". Basically he reviewed several equities with their prices and FCFps values 5 years back, and those same datas as of today.

I can't be bothered to reproduce the whole chart, but the IC is after all only £5 give or take a penny chew...but a couple of the shares are as follows:

EPIC	Company	        FCFps	Price	FCF yield
ULVR	Unilever	193.6	4140	4.70%
NXT	Next  	        329.4	5098	6.50%
FEVR	Fevertree	28.2	2677	1.10%
…

So then the penny dropped, Price to Cash Flow is more than likely the inverse of "free cash flow yield". A bit of googling:

https://investinganswers.com/education/ ... -king-1321
https://www.paceretfs.com/media/pacer_p ... ay2016.pdf

However, the links above are Stateside, and they seem to use an EV based divisor, rather than purely a market cap one.

Some stuff from Warren Buffet:

“Common yardsticks such as dividend yield, the ratio of price to earnings or to book value, and even growth rates have nothing to do with valuation except to the extent they provide clues to the amount and timing of cash flows into and from the business.”

– Warren Buffett’s 2000 Annual Letter

[SalvorHardin]

It's the cashflow equivalent of price-earnings ratio (share price divided by cashflow per share). Some investors prefer to look at cashflow instead of earnings, often to the point of ignoring reported earnings, because it is much harder to fiddle cashflow than profits.

For example, UK property companies can inflate their profits by using "generous" revaluations of their properties when the realistic market value would be lower, because our accounting rules allow unrealised changed in property value to be put in the profit & loss account. This produces higher profits without any change in cashflow. A popular trick is to book sales in the current accounting period when they really take place in the next accounting period, whilst leaving some of the costs associated with these sales in the next accounting period. This is what Tesco was caught doing in 2014. Link below:

https://www.bbc.co.uk/news/business-29716885

The tendency of some companies to produce their own figures for earnings per share (e.g. a pharmaceutical company which leaves out certain recurring costs to produce "core eps") has encouraged the use of cashflow IMHO.

[TheMotorcycleBoy]

My notifications tell me that ap8889 posted to this thread. I can't see the post.....is this the famous last post on the page issue?

ap8889 - can you be a kind soul and repost please?

Matt

[TUK020]

At one level, the answer to this is "So What?"

Don't mean to be rude, but all of the above is about getting a better handle on a company's PE ratio. However, the nature of the business will determine what level of these earnings, or cash inflow, will need to be re-invested in the core business to maintain future cash in-flows. This has a very important implication on the cash left over to re-invest on new investments, or to return to shareholders (what HYPers are very interested in).

Examples:
An Oil company gets it's cash flows from operating oil wells that run dry (surprising quickly for Fracking in 'tight' wells). It needs to reserve a significant portion of it's earnings to reinvest in new capex (drill new wells).
A consumer goods company will need to spend to maintain it's brand advertising, but will spend very little on capex to maintain it's core business.

Therefore it is reasonable to expect RDSB to run at a much lower PE ratio than Unilever.
Getting a more precise grip on the PE ratio in isolation doesn't tell you whether that company represents a good investment opportunity
tuk020

[TheMotorcycleBoy]

At one level, the answer to this is "So What?"

Don't mean to be rude, but all of the above is about getting a better handle on a company's PE ratio. However, the nature of the business will determine what level of these earnings, or cash inflow, will need to be re-invested in the core business to maintain future cash in-flows. This has a very important implication on the cash left over to re-invest on new investments, or to return to shareholders (what HYPers are very interested in).

Don't worry about perceived rudeness - you quickly qualified your earlier remark.

I was intrigued as to P/CF mainly because I'd seen it appear in amongst other quick valuation ratios

http://financials.morningstar.com/valua ... ture=en-US

and wanted to know more. I came to similar conclusion as you - i.e. that it's a turbo-charged P/E

Getting a more precise grip on the PE ratio in isolation doesn't tell you whether that company represents a good investment opportunity

Sure. I for one, am trying to consider a broad range of methodologies.

[TheMotorcycleBoy]

I forgot to say this in my last post, but I'm also finding good uses for P/E of a firm by comparing it against a) the rest of the market b) competitors c) other holdings in a portfolio for slight hints in which one to top up.