Investors seeking impressive returns irrespective of market conditions may consider adding stocks with favorable efficiency levels to their portfolios. Efficiency is a measure of a company’s potential to convert its available input into output. Different studies have shown that there is a direct relationship between a company’s efficiency level and its price movement. So investing in efficient companies may prove to be profitable.

How to Measure Efficiency?

There are a number of ratios to measure how efficiently a company utilizes its assets and liabilities to produce outputs. In this article, we have considered four popular efficiency ratios to select efficient companies.

Inventory Turnover: The ratio of 12-month cost of goods sold (COGS) to a 4-quarter average inventory is considered to be 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 resulted in 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: 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 to 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.

Screening Parameters

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 (Buy)
(Only Strong Buy and Buy rated stocks can get through.)

The use of these few criteria has narrowed down the universe of over 7,700stocks to only 22.

Here are five stocks from the 22 that made it through the screen:

Baxter International Inc. (BAX Quick QuoteBAX - Free Report) provides a portfolio of renal and hospital products. This Zacks Rank #1 (Strong Buy) company has an average four-quarter positive earnings surprise of 27%.

MAM Software Group, Inc. develops and markets software solutions. This Zacks Rank #1 company has an average four-quarter positive earnings surprise of 87.4%.

Advanced Energy Industries, Inc. (AEIS Quick QuoteAEIS - Free Report) designs, manufactures, sells, and supports power conversion products and solutions. The company has an average four-quarter positive earnings surprise of 12.3% and carries a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.

Apricus Biosciences, Inc. operates in the pharmaceutical industry and focuses on research and development in the area of drug delivery. This Zacks Rank #2 company has an average four-quarter positive earnings surprise of 32.8%.

Copart, Inc. (CPRT Quick QuoteCPRT - Free Report) provides online auctions and vehicle remarketing services. This Zacks Rank #2 company has an average four-quarter positive earnings surprise of 9.1%.

While backtesting over a two-year timeframe (Nov 28, 2014 to Nov 25, 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 6.4%. 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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