💸CASH IS KING - Corporate Multiples - KCV💸
BETTER OR NOT? The relative key figure KCV!
Since there were a few questions about the KCV under a post the other day, here is a brief explanation 😊
For the first classification of whether a company is favorably valued, the P/E ratio or KUV is often used. The KCV is often forgotten, which can also be used and offers various advantages, but also disadvantages to other relative ratios, such as the P/E or KUV.
Like the P/E ratio (price/earnings ratio) or the KUV (price/turnover ratio), the KCV (price/cash flow ratio) is a relative ratio and expresses the ratio of a share price to the cash flow per share. [1]
In contrast to the P/E ratio, cash flow rather than earnings is the relevant counterpart for determining the KCV.
Cash flow:
"Cash flow, also referred to as cash flow statement or cash flow, is a key figure that reflects the profitability of a company. It takes into account the cash flows within a company. In simple terms, when calculating cash flow, all incoming and outgoing payments within a certain period are offset against each other. The difference that results is the cash flow." [2]
We divide the cash flow statement into 3 parts. These can also be easily identified in the cash flow statement in any annual report:
-Cash flow from operating activities
-Cash flow from investing activities
=Free cash flow
-Cash flow from financing activities
=Cash flow
Free cash flow is calculated from operating cash flow less cash flow from investing activities and indicates how much money is left over to repay loans, pay dividends or buy back shares. Free cash flow is therefore a parameter often used by investors to assess strategic corporate decisions and shareholder value!
-Examples Cash flow from operating activities: Cash outflow from rental payments, cash from sales of products/services, payment of taxes, cash outflow from payment of wages and salaries.
-Examples cash flow from investing activities: purchase/sale of machinery, disposal of subsidiaries/assets.
-Examples cash flow from financing activities: payment of dividends, repayment/borrowing of loans, share buybacks, cash from capital increases
Calculation and valuation of KCV:
Calculation:
Cash flow per share / Price per share
or
Cash flow / market capitalization*
*Market capitalization = price per share x shares outstanding
For the cash flow in the calculation of the KCV, the cash flow from operating activities or the free cash flow is usually used. If key figures from different sources are used, it is therefore always important to know which cash flow was used.
Valuation:
A KCV < 1 would mean that there is more cash flow available in the company than the company is even worth or traded on the stock exchange. This would mean a huge undervaluation or that we are in a value trap and the company is in significant trouble, which is why the market is valuing the company at a junk price.
However, with relative ratios, there are generally no clear benchmarks as to when they can be considered cheap or expensive. You always have to look at comparable companies, previous periods and historical developments to classify them correctly. There are also always sector differences.
As a rule of thumb:
KCV < 15-18 favorable
P/B ratio < 1 favorable
KUV < 1 favorable
P/E < 15 favorable
PEG < 1 favorable
Below are two links to companies that have an extremely low KCV. Whether this makes them cheaply valued is not yet conclusively clear. But maybe they are worth a look (no investment advice).
European companies with high cash flows and thus low KCVs: https://www.boerse-online.de/nachrichten/aktien/kcv-von-unter-10-24-reiche-und-unterbewertete-europaeische-aktien-20332099.html
20 stocks with high cash flows and thus low KCVs: https://www.boerse-online.de/nachrichten/aktien/kcv-von-unter-10-diese-20-unterbewerteten-aktien-schwimmen-im-geld-20323270.html
Advantages KCV [1]:
- Less susceptible to accounting policy manipulation. Please have a look at my articles on impairment or big bath accounting.
- better comparability with other companies, compared to the P/E ratio (due to different accounting standards).
- the P/E ratio is not applicable for companies with losses. The KCV, on the other hand, can be used well here.
Disadvantages of KCV [1]:
-Cash flows can fluctuate more. For example, the sale of a large plant or subsidiary is directly reflected in the cash flow, but is of a one-off nature. However, such an event does not have the same effect on profit. Therefore, several comparison periods should be used.
-Although cash flow per se cannot be influenced (compared to profit), payments can be withheld by management in order to present cash flow more positively in a certain period. For investors, these measures are hardly visible. Therefore, several comparison periods should always be used.
In general, it should be noted that relative key figures only represent a "relative" value and can only provide information on whether a key figure appears favorable in comparison to previous periods or comparable companies.
Conclusion:
The KCV is a relative key figure that is often forgotten. However, it should be noted that several comparison periods are used in order to identify and interpret fluctuations in cash flow. Nevertheless, it offers some advantages. However, relative ratios should never be used in isolation. The combination of relative ratios and intrinsic valuation should be the key to success. However, to get a comprehensive picture of a company, I recommend integrating the KCV into your valuation.
Maybe this post helped you a bit more @Boarkeinname
For further and more in-depth knowledge on business valuation, I recommend the following article:
https://app.getquin.com/activity/laOUVhfFDI?lang=de&utm_source=sharing
Sources:
[1] https://www.finanzen.net/lexikon/chartanalyse/kcv
[2] https://www.weltsparen.de/glossar/cashflow/
Images:
https://www.cpapracticeadvisor.com/2014/09/05/rule-1-cash-is-king/5713/
