Investors who are unsure about the market movement in the near future may bet on companies with impressive efficiency levels. These companies are well positioned to yield impressive returns in any market conditions as the level of efficiency is positively correlated with a company’s price performance. The efficiency of a company indicates how well it utilizes its inputs to produce outputs.

How to Measure Efficiency?

There are a number of ratios to measure how efficiently a company utilizes its assets and liabilities to produce outputs. In this article, we have considered four popular efficiency ratios to select efficient companies.

Inventory Turnover: The ratio of 12-month cost of goods sold (COGS) to a 4-quarter average inventory is considered to be one of the most popular efficiency ratios. It indicates a company’s ability to maintain a suitable inventory position. While a high value indicates that the company has a relatively low level of inventory compared to COGS, a low value indicates that the company is suffering from weak sales, which resulted in excess inventory. 

Receivables Turnover: This is the ratio of 12-month sales to four-quarter average receivables. It shows a company’s potential to extend its credit and collect debt in terms of that credit. A high receivables turnover ratio or the “accounts receivable turnover ratio” or the “debtor’s turnover ratio” is desirable as it signals that the company is capable of collecting its accounts receivables or that it has quality customers.

Asset Utilization: This ratio indicates a company’s capability to convert its assets into output and is thus a widely known measure of efficiency level. It is calculated by dividing total sales over the past 12 months by the last 4-quarter average of total assets. Like the above two ratios, high asset utilization may also indicate that a company is efficient.

Operating Margin: Efficiency measure is the ratio of operating income over the past 12 months to sales over the same period. It measures a company’s ability to control its operating expenses. Hence, a high value of the ratio may indicate that the company manages its operating expenses more efficiently than its peers.

As efficiency level varies across different industries, it is best to select those stocks that have higher ratios compared to their industries. Along with higher ratios, we have considered only those stocks that have either a Zacks Rank #1 (Strong Buy) or a Zacks Rank #2 (Buy) in order to make the strategy more profitable.

Screening Parameters

Inventory Turnover, Receivables Turnover, Asset Utilization and Operating Margin greater than industry average
(Values of these ratios higher than industry averages may indicate that the efficiency level of the company is higher than its peers.)    

Zacks Rankless than or equal to #2 (Buy)
(Only Strong Buy and Buy rated stocks can get through.)

The use of these few criteria has narrowed down the universe of over 7,700 stocks to only 23.

Here are five stocks from the 23 that made it through the screen:

Heska Corporation is focused on the discovery, development and marketing of companion animal health products. This Zacks Rank #1 (Strong Buy) company has an average four-quarter positive earnings surprise of more than 100%.

Teradyne Inc. (TER Quick QuoteTER - Free Report) is a manufacturer of automatic test equipment and related software for the electronics and communications industries. This Zacks Rank #1 company has an average four-quarter positive earnings surprise of 19.3%.

Nxstage Medical, Inc. develops, manufactures and markets innovative systems for the treatment of end-stage renal disease, or ESRD, and acute kidney failure. This Zacks Rank #1 company has an average four-quarter positive earnings surprise of 46.3%. You can see the complete list of today’s Zacks #1 Rank stocks here.

Unifi Inc. (UFI Quick QuoteUFI - Free Report) is one of the world's largest producers of textured polyester and nylon, both natural and package dyed, covered elastomeric yarns and twisted yarns. This Zacks Rank #2 company has an average four-quarter positive earnings surprise of 6.4%.

Rollins Inc. (ROL Quick QuoteROL - Free Report) provides pest and termite control services to residential and commercial customers. This Zacks Rank #2 company has an average four-quarter positive earnings surprise of 2.9%.

While backtesting over a two-year timeframe (Oct 24, 2014 to Oct 21, 2016), considering a four-week holding period, a portfolio following this strategy provided a total return of 17.4% compared with the S&P 500’s return of 7.4%. Thus, this strategy may prove to be profitable for investors seeking healthy returns.

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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: https://www.zacks.com/performance.

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