Using Cash Flow to Find Value

Lately, I've been running screens to try and assess a company's real value.

The Price to Earnings ratio (P/E) is probably the most common ratio in determining whether a company is under or overvalued.

However, the Price to Cash Flow (P/CF) is another great ratio to do just that.

Cash, of course, is vital to a company's financial health. Especially nowadays, cash is needed to finance operations, invest in the business, etc.

And cash can't really be manipulated on the income statement like earnings can.

The reason why some like this measurement better than the P/E ratio is because the net income of the cash flow portion rightly adds depreciation and amortization back in, since these are not cash expenditures.

Whereas the net income that goes into the earnings portion of the P/E ratio does not include either expense, thus artificially reducing the income and skewing the P/E ratio. (Depreciation and amortization are non-cash expenditures, meaning that they don't take any money out of the company's bank account.)

So many analysts prefer using the Price to Cash Flow metric to judge a stock's value.

And just as the P/E ratio is calculated by dividing Price by its Earnings per share -- the Price to Cash Flow ratio is calculated by dividing Price by Cash Flow per share.

Finally, like a P/E ratio, the lower the number, the better.

Currently, the average Price to Cash Flow (P/CF) for the stocks in the S&P 500 is a little over 8.2. For the P/E ratio it's over 15.6.

But like the P/E ratio, a value of less than 20 is considered good.

However, make sure you compare the stocks P/CF to its industry as different industries will have different numbers that are considered normal.

The Screen

The screen I'm running today is relatively simple.

• Zacks Rank = 1 (Only Strong Buys get thru.)
• One Year Projected Growth Rate >= Average for the S&P 500 (I'm looking for above market growth rates.)
• Current Cash Flow >= 5 Year Average Cash Flow (I want to see the company's cash position improving.)
• Price to Cash Flow

There were 34 stocks that came thru this week's screen. Here are 5 of them:

AES Corporation (AES - Snapshot Report)
BJ's Wholesale Club, Inc. (BJ - Analyst Report)
CGI Group, Inc. (GIB - Snapshot Report)
Mediacomm Communications Corporation (MCCC - Snapshot Report)
Ralcorp Holdings (RAH - Snapshot Report)

Start looking for value stocks in new ways with this week's screen. Sign up now for your free trial today and start picking better stocks immediately. And with the backtesting feature, you can test your ideas to see how you can improve your trading in both up markets and down markets. Don't wait for the market to get better before you decide to do better. Start learning how to be a better trader today! You can do it. http://researchwiz.zacks.com.

Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.