Lubin Investment · Blog

High valuation: when is paying 20x a quality stock justified?

2026-06-16 ·

A P/FCF (price divided by annual cash generated) of 20x is not automatically expensive. It depends on three factors: expected FCF growth, revenue visibility (recurring or not), and the strength of the moat (competitive advantage). A company whose FCF grows 15% per year justifies a higher multiple than a stagnating one.

P/FCF: what this number really says

I always start by explaining this ratio, because misread it misleads. P/FCF (price-to-free-cash-flow) is the price you pay for the stock divided by the free cash flow (FCF) the company generates each year. FCF is the money that genuinely stays in the coffers after the company has paid all its expenses: salaries, suppliers, taxes, and also its investments in its own tools. This is not accounting profit. It is real cash.

A P/FCF of 10 means: you are paying today the equivalent of 10 years of that cash. A P/FCF of 20, that is 20 years. The higher it is, the more you pay, apparently. But 'apparently' is the key word here.

Why a P/FCF of 20x can be perfectly justified

Imagine a company whose FCF is 100 euros this year. You pay 2,000 euros for it, a P/FCF of 20x. That seems expensive. But if this FCF grows 15% per year, in five years it will be 200 euros. In ten years, 400 euros. Retrospectively, your initial 2,000 euros will have been paid at 5x the FCF of year 10. That is no longer expensive at all.

That is the first factor: expected FCF growth. The stronger and more durable it is, the more a high multiple is justified. The second factor is visibility. FCF guaranteed by multi-year contracts or recurring subscriptions is worth more than FCF dependent on one-off orders. The third factor is the moat: the competitive barrier that prevents a rival from taking this company's customers.

Three real examples from our screener

Napco Security Technologies (NSSC): this company makes physical security systems (alarms, access control) for commercial and school buildings. Its P/FCF is around 23x in June 2026. Expensive at first glance. But its FCF margin is 30%, and its recurring service revenues grew 15.4% last quarter (Q3 2026, March 2026). The moat: once a Napco system is installed in a school or a building, the replacement cost is prohibitive. Customers stay.

Paylocity (PCTY): HR and payroll software for American SMBs. Its FCF for the twelve months to March 2026 amounts to 421 million dollars, an FCF margin of 24.4%. The P/FCF is around 17.6x. Recurring revenue represents nearly all of turnover (1.73 billion annualized). The moat: switching payroll software is a long, risky and costly project for an SMB. Retention rates in this sector exceed 90%.

Qualys (QLYS): cybersecurity. FCF per share of 8.05 dollars, stock around 112 dollars, giving an EV/FCF of 12x (51% below its own historical median of 25x). Here, this is not a high P/FCF: it is a low one, while quality remains intact. An inverse case to NSSC and PCTY, but useful to illustrate that within our quality universe, valuations vary enormously.

The difference between a justified high P/FCF and a trap

The classic trap: a company shows a P/FCF of 30x because its FCF is weak this year. You tell yourself 'it will grow' without checking. If FCF does not improve, the multiple remains unsustainable indefinitely. I have learned to distinguish 'temporarily depressed FCF because the company is investing to grow' (acceptable) from 'structurally low FCF because the business does not genuinely generate cash' (a trap).

Limits of the method: what P/FCF does not tell you

P/FCF is a powerful tool, but it says nothing about the durability of the moat, management quality, or regulatory and competitive risks. That is why my method scores quality separately (10 financial criteria) from price (P/FCF compared to history). A high P/FCF is only acceptable if the quality score itself is high. You can find the updated P/FCF and quality scores for these three companies on our screener.

FAQ

What P/FCF is considered normal or reasonable?

There is no universal number. The broad US market runs around 20-25x FCF in 2026. For SaaS or high-growth software companies, P/FCF of 20-40x are common. For industrial or cyclical companies, 10-15x is more usual. The key is to compare the current P/FCF to the company's own historical median.

How do you calculate P/FCF yourself?

P/FCF = market cap (shares times price) divided by annual free cash flow. FCF is in the cash flow statement of the annual report: take 'cash from operations' and subtract capex (purchases of property, plant and equipment).

Is a P/FCF of 23x for NSSC really justified?

In my view yes, provided recurring revenue growth continues around 15% and the FCF margin stays above 28%. If growth slows to 5%, the multiple should compress. That is the main risk to watch. This is not investment advice.

What is the difference between accounting profit and free cash flow?

Accounting profit can be influenced by depreciation choices, provisions, revenue recognition. FCF measures actual cash movements. A company can show positive accounting profit while consuming cash. FCF is harder to manipulate: cash is either there or it is not.

How does our method evaluate whether a high P/FCF is justified?

I start with the quality score: if it is high (8 or above), the business durably generates FCF. Then I look at the historical FCF growth rate over 5 years. Finally I compare the current P/FCF to the company's historical median. If all three are favorable, a P/FCF of 20x can be accepted.

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About the author

Written by Lubin Danilo, founder of Lubin Investment. A self-taught individual investor, I have analyzed stocks through their fundamentals for several years and invest my own money with this method. I codified it into a tool that judges a company's quality and its price separately, using criteria drawn from the financial literature (Warren Buffett, Michael Mauboussin, Aswath Damodaran).