The Wall Street is juggling with various macro and micro issues at the moment, including U.S.-China trade dispute, Facebook data breach, apprehensions about three or more rate hikes by the Fed this year and the recent airstrike on Syria. All these events have kept the market on tenterhooks with investors scurrying for a safe haven.
What’s the Optimum Strategy?
Warren Buffett once said, “It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” The strategy is very simple – find stocks that are trading below their inherent worth.
Investment in stocks made on diligent value analysis is usually considered one of the best practices. In value investing, investors pick stocks that are cheap but fundamentally sound. So chances are high that these stocks will allow investors to book profits when the market trends upward.
There are a number of ratios to identify value stocks but none alone can conclusively determine their inherent potential. Each ratio helps an investor to understand a particular aspect of the company’s business. One such ratio, Price to Cash Flow (or P/CF), can work wonders in stock picking, if used prudently. This metric evaluates the market price of a stock relative to the amount of cash flow that the company is generating on a per share basis – the lower the number, the better.
Why Price to Cash Flow?
You must be wondering why we are considering this when the most widely used valuation metric is Price/Earnings (or P/E). Well, one of the important factors that makes P/CF a highly dependable metric is that operating cash flow adds back non-cash charges such as depreciation and amortization to net income, truly diagnosing the financial health of a company.
Analysts caution that a company’s earnings are subject to accounting estimates and management manipulation. Then again, cash flow is quite reliable. Net cash flow unveils how much money a company is actually generating and how effectively management is deploying the same.