A portfolio that comprises companies with favorable efficiency levels is poised to generate alluring returns. Efficiency – a company’s ability to transform its inputs into outputs – is a potential indicator of a company’s financial health. As the efficiency level of a company has a significant impact on its price performance, investing in companies with an impressive level of efficiency may prove to be a wise decision ahead of Thanksgiving Day.
Ratios to Evaluate Efficiency Levels
We have considered four popular ratios in order to find efficient companies that have the potential to provide impressive return.
Inventory level is one of the key indicators of a company’s business health. While a high inventory level may indicate that the company is going through a rough patch in terms of sales, a dwindling level may indicate that the company will run out of stock in a favorable sales condition. This is where inventory turnover comes into play. It is the ratio of 12-month cost of goods sold (COGS) to a 4-quarter average inventory. Thus, a high value of the ratio indicates a low level of inventory relative to COGS, while a low ratio signals that the company has excess inventory.
This ratio is used to measure a company’s capability to extend its credit and collect debts on the basis of that credit. The receivables turnover ratio or the “accounts receivable turnover ratio” or the “debtor’s turnover ratio” is calculated by dividing 12-month sales by four-quarter average receivables. While a high ratio may indicate that the company efficiently collects its accounts receivables or has quality customers, a low ratio may signal that the company has an inefficient collection procedure or has low-quality customers or an inefficient credit policy.
This is a widely used measure of a company’s efficiency. Asset utilization indicates a company’s potential to utilize its assets. It is the ratio of total sales over the past 12 months to the last 4-quarter average of total assets. So, the higher the ratio, the greater the possibility is that the company is utilizing its assets efficiently. On the contrary, a low value of the ratio may signal that it is failing to use its assets effectively.
Another popular efficiency ratio is operating margin. Operating profit margin, which is simply operating income over the past 12 months divided by sales over the same period, indicates how well a company is controlling its operating expenses. If a company has a high operating profit margin in relation to its competitors, it is doing a better job at controlling operating expenses.
All these ratios can be considered as effective measures if one compares different companies within a particular sector or industry. This is the reason why we have considered only those companies that have these ratios higher than their respective industry averages.
In addition to the above mentioned ratios, we have added a favorable Zacks Rank – Zacks Rank #1 (Strong Buy) or a Zacks Rank #2 (Buy) – to the screen with an objective to make this strategy more profitable.
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
(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 20.
Here are five stocks from the 20 that made it through the screen:
Electronic Arts Inc. (EA - Free Report) develops, markets, publishes, and distributes games, content, and services for consoles, personal computers, mobile phones, and tablets worldwide. This Zacks Rank #1 company has an average four-quarter positive earnings surprise of 29.9%.
Vanda Pharmaceuticals, Inc. (VNDA - Free Report) is a biopharmaceutical company focused on the development and commercialization of clinical-stage product candidates for central nervous system disorders. This Zacks Rank #1 company has an average four-quarter positive earnings surprise of 56.7%.
Advanced Energy Industries, Inc. (AEIS - Free Report) is a global leader in the development and support of technologies critical to high-technology, high-growth manufacturing processes. The company has an average four-quarter positive earnings surprise of 12.3%. It carries a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.
Community Bank System Inc. (CBU - Free Report) provides various banking and financial services to retail, commercial, and municipal customers. This Zacks Rank #1 company has an average four-quarter positive earnings surprise of 0.5%.
Lancaster Colony Corporation manufactures and markets three families of products: Glassware and Candles; Specialty Foods; and Automotive. This Zacks Rank #2 company has an average four-quarter positive earnings surprise of 8.6%.
While backtesting over a two-year timeframe (Nov 14, 2014 to Nov 11, 2016), considering a four-week holding period, a portfolio following this strategy provided a total return of 22.5% compared with the S&P 500’s return of 5.7%. 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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