Investors seeking strong returns may allocate their assets in stocks with significant liquidity. Liquidity is an important yardstick that indicates a company’s capability to meet debt obligations by converting assets into cash.
A company with a favorable liquidity position has the potential to generate 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 than its peers, it may also indicate that the company is failing to use its assets efficiently.
Hence, the efficiency level of a company should be considered in addition to its liquidity to identify potential winners as this combination indicates underlying financial strength.
Measures to Identify Liquid Stocks
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 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 meet its current debt obligations using the most liquid of assets. Though a cash ratio of more than 1 may point to sound financials, a higher number may indicate inefficiency in cash utilization.
So, a ratio greater than 1 is desirable at all times but may not always appropriately represent a company’s financial condition.
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 the 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 Score less than or equal to B (Back-tested results show that stocks with a Growth 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 six.
Here are four of the six stocks that qualified the screen:
Sunnyvale, CA-based Mellanox Technologies Ltd. is a leading supplier of semiconductor-based, interconnect products to world-class server, storage, and infrastructure OEMs servicing Fortune 500 data centers, the world's most powerful supercomputers, and mission critical embedded applications. The company has a Growth Score of A and delivered an average four-quarter positive earnings surprise of 16.34%. The Zacks Consensus Estimate for fiscal 2018 earnings improved 4 cents to $4.38 in the last 30 days.
Chandler, AZ-based Microchip Technology Inc. MCHP develops and manufactures microcontrollers, memory and analog and interface products for embedded control systems, which are small, low-power computers designed to perform specific tasks. The company has a Growth Score of B and delivered an average four-quarter positive earnings surprise of 3.85%. The Zacks Consensus Estimate for fiscal 2019 earnings remained unchanged at $6.57 in the last 30 days.
Headquartered in Houston, TX ConocoPhillips COP is involved in exploration, development and production of crude oil and natural gas worldwide. The company has a Growth Score of A and delivered an average four-quarter positive earnings surprise of 226.88%. The Zacks Consensus Estimate for fiscal 2018 earnings of $4.28 increased 4.14% in the last 30 days.
Based in San Jose, CA, Adobe Systems Incorporated ADBE is one of the largest software companies in the world, offering a line of products and services used by creative professionals, marketers, knowledge workers, application developers, enterprises and consumers. The company has a Growth Score of B and delivered an average four-quarter positive earnings surprise of 8.94%. The Zacks Consensus Estimate for fiscal 2018 earnings of $6.64 increased 2 cents in 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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