Liquidity is an important yardstick that indicates a company’s capability to meet debt obligations by converting assets into cash. Liquid stocks have always been in demand owing to their potential to provide maximum returns.
A company with a favorable liquidity position always has the potential to provide higher returns as liquidity drives growth. However, one should exercise caution before investing in such stocks. While a high liquidity level may imply that the company is meeting its obligations at a faster rate compared to peers, it may also indicate that the company is failing to use its assets efficiently.
Hence, one may consider the efficiency level of a company in addition to its liquidity to identify potential winners.
Measures to Identify Liquid Stocks
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 desirable at all times but may not always underline a company’s financial health.
In order to pick the best of the lot, 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. Though this ratio varies across industries, companies with a ratio higher than their respective industries can be considered efficient.
In order to ensure that these liquid and efficient stocks have solid growth potential, we have added our proprietary Growth Style Score to the screen.
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 (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 handily beat other stocks.)
These criteria have narrowed down the universe of over 7,700 stocks to only eight.
Here are five of the eight stocks that qualified the screen:
Applied Materials Inc. (AMAT - Free Report) provides manufacturing equipment, services and software to the semiconductor, display, and related industries worldwide. The company has a Growth Style Score of ‘B’ and an average four-quarter positive earnings surprise of 3.92%. The Zacks Consensus Estimate for 2017 earnings increased 1.1% (3 cents) to $2.65 over the last 30 days.
Applied Materials’ one-year return of 85.7% is better than the Zacks Semiconductor Equipment - Wafer Fabrication industry’s gain of 51.5%.
Milpitas, CA-based Lumentum Holdings Inc. (LITE - Free Report) is a manufacturer and seller of innovative optical and photonic products. The company has a Growth Style Score of ‘A’ and an average four-quarter positive earnings surprise of 17.27%. Moreover, the Zacks Consensus Estimate for 2017 earnings increased by a penny to $1.68 over the last 30 days.
Lumentum’s one-year return of 78.3% is higher than the Zacks Lasers-Systems and Components industry’s addition of 33.5%.
San Francisco, CA-based Square Inc (SQ - Free Report) offers financial and marketing services. The company has a Growth Style Score of ‘B’ and an average four-quarter positive earnings surprise of 23.33%. The Zacks Consensus Estimate for 2017 has remained steady at a loss of 25 cents over the last 30 days.
Square’s one-year return of 12.4% is much better than the Zacks Internet Software industry’s increase of 9.6%.
Zendesk Inc. (ZEN - Free Report) provides a software-as-a-service, or SaaS, customer service platform. It provides customer service in a wide range of languages in various industries. The company has a Growth Style Score of ‘A’ and an average four-quarter positive earnings surprise of 12.68%. Further, the Zacks Consensus Estimate for 2017 has remained stable at a loss of 99 cents over the last 30 days.
Zendesk’s one-year return of 30.7% is better than the Zacks Internet Software industry’s gain of 9.6%.
Headquartered in Michigan, Visteon Corp. (VC - Free Report) operates as an automotive supplier engaged in the design, engineering and manufacturing of innovative climate, electronic, interior and lighting products for vehicle manufacturers. The company has a Growth Style Score of ‘B’ and an average four-quarter positive earnings surprise of 47.09%. The Zacks Consensus Estimate for 2017 earnings remained steady at $5.51 over the last 30 days.
Visteon gained 24.2% in the last one year, compared with the Zacks Auto/Truck Original Equipment industry’s gain of 18.7%.
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