Companies with a favorable liquidity position have always been in demand as they are believed to have the potential to boost portfolio returns. However, one should be careful before investing in liquid stocks. While a high liquidity level may mean that the company is meeting its obligations at a faster rate compared to others in its domain, it may also indicate that the company is failing to use its assets efficiently.

Hence, one may consider the efficiency level of a company in addition to its liquidity to identify potential winners as this combination is indicative of underlying financial strength.

Measures to Identify Liquid Stocks

Current, quick and cash ratios are considered as the main pointers 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, the 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 calculating 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 considered asset utilization 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 (Buy) handily beat other stocks.)

Using a handful of these criteria, we’ve narrowed down the universe of over 7,700 stocks to only 14.

Here are 5 of the 14 stocks making it through the screen:

The Children's Place, Inc. (PLCE Quick QuotePLCE - Free Report) is a specialty retailer of apparel and accessories for children from newborn to twelve years of age. Children's Place has a Growth Style score of ‘A’ and an average four-quarter positive earnings surprise of nearly 33.1%.

Zendesk, Inc. provides a software-as-a-service, or SaaS, customer service platform. It provides customer service in a wide range of languages in various industries. Zendesk has a Growth Style score of ‘A’ and an average four-quarter positive earnings surprise of 10.9%.

Oclaro, Inc. is a tier 1 provider of high performance optical components, modules and subsystems to the telecommunications market. Oclaro has a Growth Style score of ‘A’ and an average four-quarter positive earnings surprise of more than 100%.

National Research Corp. offers analytics and insights that facilitate revenue growth, patient, employee, customer retention and patient engagement. The company has a Growth Style score of ‘A’ and an average four-quarter positive earnings surprise of 2.7%.

Urban Outfitters Inc. (URBN Quick QuoteURBN - Free Report) operates two business segments consisting of a lifestyle-oriented general merchandise retailing segment and a wholesale apparel business. Urban Outfitters has a Growth Style score of ‘A’ and an average four-quarter positive earnings surprise of 6.7%.

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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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