Liquidity indicates a company’s capability of meeting debt obligations by converting assets into liquid cash and equivalents. Companies with a favorable liquidity position have always been in demand as these are believed to have the potential to boost portfolio returns.
However, one should be cautious before investing in liquid stocks. While a high liquidity level may mean that the company is meeting its obligations at a faster rate compared to others in its domain, it may also indicate that the company is failing to use its assets efficiently.
Hence, one should consider the efficiency level of a company in addition to its liquidity to identify potential winners as this combination is indicative of underlying financial strength.
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 to measure 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 ideal.
Quick Ratio: Unlike current ratio, quick ratio – also called “acid-test ratio" or "quick assets ratio" – indicates a company’s ability to meet 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 meet its current debt obligations using the most liquid of assets. Though a cash ratio of over 1 may point to sound financials, a high number may indicate inefficiency in cash utilization.
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 12.
Here are four of the 12 stocks that qualified the screen:
Headquartered in Simpsonville, SC, KEMET Corporation (KEM - Free Report) manufactures and sells passive electronic components under the KEMET brand worldwide. It is the world's largest manufacturer of solid tantalum capacitors and one of the biggest manufacturers of multilayer ceramic capacitors. The company has a Growth Style Score of ‘A’ and an average four-quarter positive earnings surprise of 72.92%. Moreover, the Zacks Consensus Estimate for 2017 earnings has increased a couple of penny to 90 cents over the last 30 days.
San Francisco, CA-based Square Inc. (SQ - Free Report) offers financial and marketing services. The company has a Growth Style Score of ‘A’ and an average four-quarter positive earnings surprise of 45.84%. The Zacks Consensus Estimate for 2017 remained stable at a loss of 16 cents over the last 30 days.
Based in Chicago, IL, Telephone and Data Systems Inc. (TDS - Free Report) is a diversified telecom service provider offering wireless and wireline services in 36 states. The company has a Growth Style Score of ‘A’ and an average four-quarter positive earnings surprise of 802.41%. The Zacks Consensus Estimate for 2017 earnings remained unchanged at 30 cents per share over the last 30 days.
Hanover, MD-based Ciena Corp (CIEN - Free Report) provides equipment, software, and services supporting transport, switching, aggregation, service delivery, and management of voice, video, and data traffic on communications networks worldwide. The company has a Growth Style Score of ‘B’ and an average four-quarter positive earnings surprise of 7.84%. The Zacks Consensus Estimate for 2017 earnings remained steady at $1.49 per share over the last 30 days.
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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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