Investors seeking to derive higher returns may consider investing in relatively liquid stocks. Liquidity is a measure of identifying financially strong companies. It indicates how fast a company can convert its assets to meet its short-term debt obligations.
However, a high liquidity level may not always mean that the company is meeting its obligations at a faster rate compared to others in its domain. The same may also indicate that the company is not using its assets efficiently. Hence, to judge whether a company is financially strong or not, besides its liquidity, the efficiency level should be taken into consideration.
So, investing in efficient companies, which also have relatively higher liquidity levels, may boost one’s portfolio returns.
Key Ratios to Indicate Liquidity
Current, quick and cash ratios are considered as the main indicators of the liquidity level of a company. Current ratio or working capital ratio indicates a company’s potential to meet both short- and long-term debt obligations by measuring current assets relative to current liabilities. Contrastingly, quick ratio or acid-test ratio or quick assets ratio only seeks to measure a company’s ability to pay short-term obligations. Due to this, current assets excluding inventory are considered in building up the quick ratio.
Separately, the cash ratio – the most conservative of the three ratios – indicates a company’s potential to convert its most liquid assets to pay current debt obligations. This is the reason why it only considers cash and cash equivalents relative to the company’s current liabilities. Values of all these ratios above 1 may signal that the company is in good financial shape. However, high values of these ratios may also indicate that the company has failed to utilize its assets significantly. Hence, we consider liquidity ratios between 1 and 3 for healthy choices.
Screening Parameters
In addition to favorable liquidity ratios, we included asset utilization in our screening parameters in order to avoid screening high liquid but inefficient companies. Asset utilization, which is a ratio of total sales over the past 12 months to the last four-quarter average of total assets, is a widely used measure of a company’s efficiency. A company with high asset utilization is considered to be efficient.
Also, we have added our proprietary Growth Style Score to the screen with an objective to ensure that these liquid and efficient stocks have solid growth potential too.
Current Ratio, Quick Ratio and Cash Ratio between 1 and 3
(While liquidity ratios of greater than 1 are desirable, significantly high ratios may indicate inefficiency)
Asset utilization greater than industry average
(Higher asset utilization than the industry average indicates a company’s efficiency.)
Zacks Rank equal to #1
(Only Strong Buy rated stocks can get through.)
Growth Style Score less than or equal to B
(Back-tested results show that stocks with a Growth Style Score of ‘A’ or ‘B’ when combined with a Zacks Rank #1 or #2 handily beat other stocks.)
Just these few criteria have narrowed down the universe of over 7,700 stocks to only 13.
Here are five stocks from the list:
Cable ONE, Inc. ( (NYSE:CABO) )
Amphastar Pharmaceuticals, Inc. ( (NASDAQ:AMPH) )
Shutterstock, Inc. ( (NYSE:SSTK) )
Masimo Corporation ( (NASDAQ:MASI) )
American Public Education, Inc. ( (NASDAQ:APEI) )
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Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.
Disclosure: Performance information for Zacks’ portfolios and strategies are available at: http://www.zacks.com/performance.
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AMER PUB EDUCAT (APEI): Free Stock Analysis Report
AMPHASTAR PHARM (AMPH): Free Stock Analysis Report
MASIMO CORP (MASI): Free Stock Analysis Report
SHUTTERSTOCK (SSTK): Free Stock Analysis Report
CABLE ONE INC (CABO): Free Stock Analysis Report
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Zacks Investment Research