Liquidity indicates a company’s capability to meet debt obligations by converting assets into 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
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 higher than 1 may point to sound financials, a high 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.)
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 four of the eight stocks that qualified the screen:
Watertown, MA-based athenahealth, Inc (NASDAQ:ATHN), through its cloud-based network athenaNet, provides services that manage the administrative duties of medical providers. The company has a Growth Score of A and an average four-quarter positive earnings surprise of 21.45%. The Zacks Consensus Estimate for fiscal 2018 earnings per share has increased 21.2% to $3.54 over the last 30 days.
New Albany, OH-based Commercial Vehicle Group, Inc. (NASDAQ:CVGI) is a supplier of cab-related products for the global commercial vehicle market, including the heavy-duty truck market, the construction and agricultural market and other specialized transportation markets. The company has a Growth Score of B and an average four-quarter positive earnings surprise of 127.18%. The Zacks Consensus Estimate for 2018 earnings has increased by 5 cents to $1.22 over the last 30 days.
Irving, Texas-based Pioneer Natural Resources (NYSE:PXD) is an independent oil and gas exploration and production company. The company has a Growth Score of A and an average four-quarter positive earnings surprise of 66.92%. The Zacks Consensus Estimate for 2018 earnings has increased 42.6% to $5.39 over the last 30 days.
Redwood City, CA-based Shutterfly, Inc. (NASDAQ:SFLY) is a leading provider of Internet-based social expression and personal publishing service. Through its broad range of leveraged technology, manufacturing, web-design and merchandising capabilities customers can share, print and preserve their digital photographs. The company has a Growth Score of A and an average four-quarter positive earnings surprise of 12.99%. The Zacks Consensus Estimate for fiscal 2018 earnings rose 37.5% to $2.09 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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