The value of this rating is an indication of the relationship between the price at which the company trades on the stock exchange and the free cash flows of the last ten accounting periods. A high rating will indicate that the quote price is low relative to the free cash flows. A low rating will indicate a high price in relation to these cash flows.
The following table can serve as a reference for the use of this rating:
|Rating value range||Interpretation|
|0 - 2||Very high company price in relatio to its free cash flow|
|2 - 5||High company price in relatio to its free cash flow|
|5 - 8||Company price proportional to its free cash flow|
|8 - 10||Low company price in relation to its free cash flow|
There are several ways to measure the company's free cash flow. In Gradement we define and measure it as the cash flow available to shareholders after deducting any operating expenses, capital expenditures (both current and fixed) and financial expenses.
Free cash flow is the main magnitude with which we, in Gradement, compare prices to measure the undervaluation or overvaluation of the shares of a particular company.
The main advantage of using the free cash flow over just using the earnings as reported is that the calculation of this earnings is done using accrual accounting, whereas for cash flow the cash method is used.
The greater flexibility of the accrual method regarding the application of accounting criteria (terms and types of depreciation, provisions, temporary recognition of income and expenses, etc.) increases the complexity and the occurrence of errors, and also, in certain cases, the abuse of these criteria to present manipulated accounting figures. Conversely, manipulation of cash-based figures is much more difficult, and therefore, these cash-based variables tends to adjust more accurately to the economic and financial reality of the company, especially if they are considered over several accounting periods, as it's done by Gradement.