Picking Great Stocks (Part 2 of 4)
In this series there are four important ratios when looking at stocks. Price to cash, price to earnings, price to sales, and price to book. In part 1 of 4 we talked about price to earnings. In part 2 we are going to talk about price to cash.
What is it?
Simply, it’s the stock price divided by the cash and cash equivalents that the company has in their bank account. Basically it just tells you how much cash the company has on hand relative to the stock price.
Why is this important?
This ratio is equivalent to the amount of cash you have sitting in your bank account doing nothing. You want cash in your account to cover unforeseen expenses.
For example, if your kid has to go to the emergency room and you now have a large hospital bill. If you have a lot of cash in your bank account, you can just pay for that hospital bill. If you don’t have any cash in your bank account, then you most likely have to take out a loan or sell something to cover that medical expense.
It works the same way with companies. They need to keep cash on hand for unforeseen expenses as well as foreseen expenses like new projects, investments, etc. Otherwise, if they don’t have cash on hand, then they need to borrow money or sell something to pay for non-scheduled expenses.
OK, so I want my company to have cash on hand. How much should they have?
Warren Buffett and Benjamin Graham advocate for a Price to Cash Ratio of 10. The graph below also shows what the Price to Cash Flow (PCF – same as Price to Cash) should be depending if you are a value investor or Growth investor.
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Also, I have lots more free resources that provide great investing advice no matter what level of investor you are. You can grab them by clicking on the Free Resources tab above.