The potential of efficient companies to provide impressive returns irrespective of market conditions makes them a popular choice among investors. A company’s ability to transform its input into output, which is commonly known as its efficiency level, indicates whether the firm is financially healthy or weak. Moreover, it is believed that the efficiency level is positively correlated with a company’s price performance.
Key Ratios to Measure Efficiency
Sometimes it becomes difficult to measure the efficiency level of a company. This is the reason why one must consider popular efficiency ratios to select potential stocks in order to build a profitable portfolio. These efficiency ratios are:
Inventory Turnover: The ratio of 12-month cost of goods sold (COGS) to a 4-quarter average inventory, is considered as 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 led to 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:This 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 with 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.
Inventory Turnover, Receivables Turnover, Asset Utilization and Operating Margin greater than industry average: The values of these ratios higher than the industry averages may indicate that the efficiency level of the company is higher than its peers.
Zacks Rankless than or equal to #2: Only Strong Buy and Buy rated stocks can get through.
The use of these very few criteria has narrowed down the universe of over 7,700stocks to only 21.
Here are five stocks from the 21 that made it through the screen:
Cooper Tire & Rubber Co. (CTB - Free Report) specializes in the manufacture and marketing of automotive products. This Zacks Rank #1 company has an average four-quarter positive earnings surprise of 22.1%.
Ultra Petroleum Corp. (UPLMQ - Free Report) is an independent, exploration and production company focused on developing its long life natural gas reserves. It has an average four-quarter positive earnings surprise of 65.9%. The stock carries a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.
LyondellBasell Industries N.V. (LYB - Free Report) manufactures chemicals and derivatives. It also operates as a refiner of heavy high-sulfur crude oil produce and is engaged in the marketing and selling of polymers. This Zacks Rank #2 company has an average four-quarter positive earnings surprise of 4.8%.
Apogee Enterprises, Inc. (APOG - Free Report) is a leader in technologies involving the design and development of value-added glass products and services. This Zacks Rank #2 company has an average four-quarter positive earnings surprise of 13.6%.
Summit Materials, Inc. (SUM - Free Report) is a construction material company that supplies aggregates, cement, ready-mix concrete and asphalt. This Zacks Rank #2 company has an average four-quarter positive earnings surprise of 11.7%.
While backtesting over a two-year timeframe (Sep 26, 2014 to Sep 23, 2016), considering a four-week holding period, a portfolio following this strategy provided a total return of 15.2% compared with the S&P 500’s return of 7.5%. 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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