A company with a favorable efficiency level is expected to provide impressive returns as it is believed to be positively correlated with the company’s price performance. Hence, efficiency or the company’s ability to transform its inputs into outputs is an important measure to determine its financial condition.
However, it is difficult to measure the efficiency level of a company. This is the reason why one must consider popular efficiency ratios while selecting stocks to build a profitable portfolio.
Ratios to Evaluate Efficiency Levels
We have considered four popular ratios in order to find efficient companies that have the potential to provide impressive returns.
This ratio is used to measure a company’s capability to extend its credit and collect debts on the basis of that credit. 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 indicates that the company efficiently collects its accounts receivables or has quality customers, a low ratio signals that the company has an inefficient collection procedure or has low-quality customers or an inefficient credit policy.
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 is a widely used measure of a company’s efficiency. Asset utilization indicates a company’s potential to utilize its assets. It is a 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 is the chance that the company is utilizing its assets efficiently. On the contrary, a low value of the ratio signals 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 higher ratios 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 2 (Buy) – to the screen with an objective to make this strategy more profitable.
Receivables Turnover, Inventory 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 Rank better than or equal to 2
(Only Zacks Rank #1 or 2 stocks can get through)
The use of these few criteria has narrowed down the universe of over 7,700 stocks to only 17.
Here are five stocks from the 17 that made it through the screen:
American Woodmark Corporation AMWD manufactures and distributes kitchen cabinets and vanities for the remodeling and home construction markets in the U.S. This Zacks Rank #1 company has an average four-quarter positive earnings surprise of 10.59%. Heska Corporation HSKA manufactures and markets advanced veterinary diagnostic and specialty products for canine and feline healthcare markets in the U.S. and internationally. This Zacks Rank #1 company has an average four-quarter positive earnings surprise of 291.54%. OraSure Technologies, Inc. OSUR develops, manufactures, markets, and sells oral fluid diagnostic products and specimen collection devices in the U.S. and internationally. This Zacks Rank #2 company has an average four-quarter positive earnings surprise of 123.54%. You can see . the complete list of today’s Zacks #1 Rank stocks here Pioneer Natural Resources Company ( PXD Quick Quote PXD - Free Report) operates as an independent oil and gas exploration and production company in the U.S. This Zacks Rank #1 company has an average four-quarter positive earnings surprise of 21.86%. Advanced Energy Industries, Inc. AEIS designs, manufactures, sells, and supports power conversion and control products that transform power into various usable forms. This Zacks Rank #1 company has an average four-quarter positive earnings surprise of 17.10%.
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