Identifying stocks that offer healthy returns may sometimes prove to be difficult for investors. In that case, one may consider liquidity levels, which are a good indicator of a company’s financial health.
Liquidity is a measure of a company’s capability to meet its short-term debt obligations. Stocks with high liquidity levels have always been in demand owing to their potential to provide maximum returns.
However, one should be careful before investing in such stocks. While a high liquidity level may imply that the company is clearing its dues at a faster rate compared with peers, it may also suggest that the company is failing to use assets efficiently.
Therefore, in addition to liquidity level, an investor may also consider the efficiency of the company before investing in the stock. An efficient company with a favorable liquidity level may prove to be a profitable addition to one’s portfolio.
Measures to Identify Liquid Stocks
Current Ratio: It measures current assets relative to current liabilities. This ratio is used for measuring a company’s potential to meet both short- and long-term debt obligations. Thus, a current ratio — also known as working capital ratio — below 1 indicates that the company has more liabilities than assets. However, a high current ratio does not always indicate that the company is in good financial shape. It may also mean that the company has failed to utilize its assets significantly. Hence, a range of 1 to 3 is considered ideal.
Quick Ratio: Unlike current ratio, quick ratio — also called “acid-test ratio" or "quick assets ratio" — indicates a company’s ability to pay short-term obligations. It considers inventory excluding current assets relative to current liabilities. Like the current ratio, a quick ratio of greater than 1 is desirable.
Cash Ratio: This is the most conservative ratio among the three, as it takes into account only cash and cash equivalents, and invested funds relative to current liabilities. It measures a company’s ability to meet its current debt obligations using the most liquid of assets. Though a cash ratio of more than 1 may point to sound financials, a higher number may indicate inefficiency in cash utilization.
So, a ratio greater than 1 is desirable at all times but may not always appropriately represent a company’s financial condition.
In order to pick the best of the lot, we have added asset utilization, which is a widely used measure of a company’s efficiency, as one of the screening criteria. Asset utilization is the ratio of total sales over the past 12 months to the last four-quarter average of total assets. Though this ratio varies across industries, companies with a ratio higher than their respective industries can be considered efficient.
In order to ensure that these liquid and efficient stocks have solid growth potential, we have added our proprietary Growth Style Score to the screen.
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). You can see the complete list of today’s Zacks #1 Rank stocks here.
Growth Score less than or equal to B (Back-tested results show that stocks with a Growth Score of A or B when combined with a Zacks Rank #1 or 2 handily beat other stocks.)
These criteria have narrowed down the universe of more than 7,700 stocks to only five.
Here are four of the five stocks that qualified the screen:
Domiciled in Lynnwood, WA, Zumiez Inc. (ZUMZ - Free Report) is one of the leading global lifestyle retailers. The company through its distinctive brand offering and diverse product selection has carved a niche in the rapidly changing apparel industry. The Zacks Consensus Estimate for its fiscal 2020 earnings has been revised upward by 59.9% to $2.51 in the past 60 days. The company has a Growth Score of A. It has a trailing four-quarter earnings surprise of 41.23%, on average.
Headquartered in Columbus, OH, Installed Building Products, Inc. (IBP - Free Report) is a notable company in the building products and equipment space. It offers solutions involving the installation of insulation, fire-stopping, fireproofing, waterproofing, garage doors, rain gutters, shower doors, window blinds, closet shelving and mirrors, and other products across the continental United States. The Zacks Consensus Estimate for its current-year earnings has been revised upward by 38% to $4.14 in the past 60 days. The company has a Growth Score of A. It has a trailing four-quarter earnings surprise of 23.34%, on average.
Baltimore, MD-based Medifast, Inc. (MED - Free Report) manufactures and distributes weight loss, weight management, healthy living products, and other consumable health and nutritional products. The Zacks Consensus Estimate for its current-year earnings has been revised upward by 12.8% over the last 60 days to $8.17 per share. The company has a Growth Score of A. It has a trailing four-quarter earnings surprise of 15.8%, on average.
Based in Southborough, MA, Virtusa Corporation (VRTU - Free Report) provides digital engineering and information technology (IT) outsourcing services primarily in North America, Europe and Asia. The Zacks Consensus Estimate for fiscal 2021 earnings has been revised upward by 24.7% to $2.07 in the past 60 days. The company has a Growth Score of B. It has a trailing four-quarter earnings surprise of 6.97%, on average.
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