Price-to-free-cash-flow (P/FCF) ratio

FCF = ( earnings before interest and tax ) * ( 1 – tax rate ) +
depreciation + amortization – ( change in net working capital ) –
( capital expenditures )

Free cash flow is the total amount of cash brought in by
operations minus the amount of cash that was used for capital
expenditure.

When using P/FCF as value measure, companies embarking on major
growth initiatives are penalized. Given sufficient opportunity
and proclivity, most managers become capital destroyers.

By establishing how much cash a company has after paying its bills
for ongoing activities and growth, FCF is a measure that aims to
cut through the arbitrariness and "guesstimations" involved in
reported earnings.

Earnings can often be clouded by accounting gimmicks, but it's
tougher to fake cash flow. For this reason, some investors
believe that FCF gives a much clearer view of the ability to
generate cash (and thus profits). It is important to note that
negative free cash flow is not bad in itself. If free cash flow is
negative, it could be a sign that a company is making large
investments. If these investments earn a high return, the
strategy has the potential to pay off in the long run.

First, compare current ratios to the industry that the company
competes in.

Second, compare the current ratio against a company’s historical
ratio to see if today’s prices are within reason.

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