Identifying stocks that offer healthy returns may sometime prove to be difficult for investors. In that case, one may take into account liquidity levels as it is considered to be a good indicator of a company’s financial health. Liquidity is a measure of a company’s capability to meet its short-term debt obligations.
However, high liquidity may also signify a company’s inefficiency to utilize its assets effectively. Thus, impressive liquidity positions and favorable efficiency levels indicate solid financial health.
Let’s Look at Liquidity Ratios
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 always desirable but it may not always underline a company’s financial health.
In order to avoid selection of inefficient companies, 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. Since this ratio varies across industries, companies with a ratio higher than their respective industries can be called efficient.
In order to make the strategy more profitable, we have added our proprietary Growth Style Score to the screen with an objective to ensure that these liquid and efficient stocks have solid growth potential too.
- 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 (Strong Buy)
(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 (Buy) handily beat other stocks.)
Just these few criteria have narrowed down the universe of over 7,700 stocks to only 10.
Here are five stocks from the list:
NIC Inc. (EGOV) is a provider of Internet-based, electronic government services. NIC has a Growth Style Score of ‘A’ and an average four-quarter positive earnings surprise of 16%.
WellCare Health Plans, Inc. (WCG) provides managed care services targeted exclusively toward government-sponsored healthcare programs. WellCare Health Plans has a Growth Style Score of ‘A’ and an average four-quarter positive earnings surprise of 40%.
CBOE Holdings, Inc (CBOE) operates as an options exchange and creator of listed options in the U.S. CBOE Holdings has a Growth Style Score of ‘B’ and an average four-quarter positive earnings surprise of 1.4%.
Littelfuse, Inc. (LFUS) is a leading manufacturer and seller of fuses and other circuit protection devices. Littelfuse has a Growth Style Score of ‘B’ and an average four-quarter positive earnings surprise of 3.5%.
Radian Group Inc (RDN) provides mortgage and real estate products and services in the U.S. Radian Group has a Growth Style Score of ‘B’ and an average four-quarter positive earnings surprise of 5.9%.
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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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