Free cash flow divided by net income. Above 1.0 means the company generates more cash than its reported profits, a hallmark of high-quality earnings. Consistently below 0.7 is a red flag.
Formula
Description
Measures how effectively net income converts into free cash flow. A ratio above 1.0 means the company generates more cash than its accounting profits suggest, which is a hallmark of high-quality earnings. Below 1.0 may indicate aggressive revenue recognition or heavy capex needs.
Interpretation
Above 1.0 is a positive quality signal. Consistently below 0.7 is a red flag, suggesting earnings may not be backed by cash. Companies with high depreciation relative to capex often show ratios well above 1.0.
Related Integrity Indicators
Operating cash flow divided by total debt. Measures how quickly a company could repay all its debt from operating cash flow alone. Above 0.5 means the company could theoretically pay off all debt in two years from operations. Below 0.15 signals heavy debt relative to cash generation.
Compares operating cash flow to net income. When cash flow exceeds earnings, the company's profits are well-supported by actual cash. This is one of the nine criteria in the Piotroski F-Score.
What percentage of revenue must be reinvested in capital assets. Below 8% is capital-light and attractive. Buffett prefers businesses that don't require large ongoing capital outlays to maintain their competitive position.
What percentage of operating cash flow is consumed by capital expenditures. The remainder is free cash flow. Below 40% leaves ample cash for dividends, buybacks, and growth investments.
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