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Building a portfolio comprising stocks with favorable liquidity is the way to go for investors seeking healthy returns. Liquidity is a measure of a company’s capability to meet its short-term debt obligations. Thus, companies boasting impressive liquidity positions may be considered to be the ones with solid financial health.

However, high liquidity may also signify a company’s inefficiency to utilize its assets effectively. It is therefore important to also focus on efficiency alongside liquidity to identify potential winners. 

Liquidity Ratios

Liquidity ratios like Current Ratio, Quick Ratio and Cash Ratio are primarily used to identify companies with strong liquidity.

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 to be 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 pay its current debt obligations using the most liquid of assets. Though a cash ratio higher than 1 may point to sound financials, a high number may indicate inefficiency in using the cash.

So, a ratio of greater than 1 is always desirable but it may not always underline a company’s financial health.

Screening Parameters

In order to avoid selection of inefficient companies, 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 a ratio of total sales over the past 12 months to the last four-quarter average of total assets. Since this ratio varies across industries, companies with a ratio higher than their respective industries can be called efficient.

In order to make the strategy more profitable, 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 (Strong Buy)
(Only Strong Buy rated stocks can get through. You can see the complete list of today’s Zacks #1 Rank stocks here.) 

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.)

Just these few criteria have narrowed down the universe of over 7,700 stocks to only 15.

Here are five stocks from the list:

Francesca's Holdings Corporation (FRAN - Free Report) offers apparel, jewelry, accessories, and gifts for female customers. Francesca's Holdings has a Growth Style Score of ‘A’ and an average four-quarter positive earnings surprise of 15.4%.

Argan, Inc. (AGX - Free Report) provides inside premise wiring services to the federal government and also provides underground and aerial construction services and splicing to major telecommunications and utilities customers. Argan has a Growth Style Score of ‘A’ and an average four-quarter positive earnings surprise of 13.3%.

Lumentum Holdings Inc. (LITE - Free Report) is a manufacturer of innovative optical and photonic products. Lumentum Holdings has a Growth Style Score of ‘A’ and an average four-quarter positive earnings surprise of 24.5%.

Oclaro, Inc. (OCLR - Free Report) is a leading provider of high performance optical components, modules, and subsystems for the telecommunications market. Oclaro has a Growth Style Score of ‘A’ and an average four-quarter positive earnings surprise of more than 100%.

Cable ONE, Inc. (CABO - Free Report) provides Internet, cable television and telephone service primarily in the U.S. Cable ONE has a Growth Style Score of ‘B’ and an average four-quarter positive earnings surprise of 12.2%.

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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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