Some analysts consider cash flow as perhaps a company’s most important financial barometer, and the ratio of stock price to operating cash flow is favored by many over the price-earnings (P/E) ratio as a measure of a company’s value. Operating cash flow -- which is comprised of net earnings minus preferred dividends plus depreciation -- is arguably the best measure of a business’s profits. A company can show positive net earnings and still not be able to pay its debts. It’s cash flow that pays the bills -- and underwrites dividend checks to stockholders.

Price-to-cash-flow ratios vary widely from industry to industry, with capital-intensive industries such as auto manufacturing or cable TV tending to have very low multiples, and less infrastructure-heavy industries, like software, sporting much higher ones. At this writing, the price-to-cash-flow ratio for the Standard & Poor's 500 companies is about 14. In other words, for every $1 that flows through those companies, their stock price is $14. But the average price-to-cash-flow ratio in the auto industry is 5, and in the software industry it’s 39.

Price-to-cash flow is particularly favored to value companies in the "hard asset" business -- gold, oil, and real-estate companies, for example.

Generally, the higher this ratio and the larger the gap between its multiple and the industry average, the more likely that the firm may be overvalued. But that doesn’t mean you should race out and sell your stock. The firm may have earned its higher multiple by a track record of above-average earnings growth, for example. You may want to dig deeper.
-- Check out other measures of the company's value -- it's price-to-earnings ratio, for example, or its price-to-sales ratio. How do those compare with other firms in its industry?
-- What is the company's growth rate, and how does that compare with the industry average? A popular benchmark is to compare the company's price-earnings multiple with its forecast earnings growth rate for the next year. A company's stock may seem expensive at 35 times earnings, but if it is growing at 40% a year, it could be a bargain.
-- Check out the company’s statement of cash flows. Has the trend been up or down recently?
-- Calculate the firm’s cash flow per share of stock. (Divide its annual free cash flow, from the cash flow statement, by the total number of common shares outstanding, from the balance sheet). This will help you understand how a potential acquirer might value the company. Firms with large cash flows are often attractive takeover targets, since part of the acquisition can be paid for with the acquired firm’s own cash.