Companies with favorable efficiency levels are likely to be on investors’ radar irrespective of market conditions. After all, efficiency is a potential indicator of a company’s financial health.
Moreover, a company with a favorable efficiency level is expected to provide impressive returns as it is believed to be positively correlated with its price performance.
How to Measure Efficiency?
We have considered four popular ratios in order to find efficient companies that have the potential to provide impressive returns.
Inventory level is one of the key indicators of a company’s business health. While a high inventory level may indicate that the company is going through a rough patch in terms of sales, a dwindling level may indicate that it will run out of stock in a favorable sales condition.
This is where inventory turnover comes into play. It is the ratio of 12-month cost of goods sold (COGS) to a 4-quarter average inventory. Thus, a high value of the ratio indicates a low level of inventory relative to COGS, while a low ratio signals that the company has excess inventory.
This ratio is used to measure a company’s capability to extend its credit and collect debts on the basis of that credit. Receivables turnover ratio or the “accounts receivable turnover ratio” or the “debtor’s turnover ratio” is calculated by dividing 12-month sales by four-quarter average receivables.
While a high ratio indicates that the company efficiently collects its accounts receivables or has quality customers, a low ratio signals that the company has an inefficient collection procedure or has low-quality customers or an inefficient credit policy.
This is a widely used measure of a company’s efficiency. Asset utilization indicates a company’s potential to utilize its assets. It is a ratio of total sales over the past 12 months to the last 4-quarter average of total assets.
So, the higher the ratio, the greater is the chance of the company utilizing its assets efficiently. On the contrary, a low value of the ratio signals that it is failing to use its assets effectively.
Another popular efficiency ratio is operating margin. Operating profit margin, which is simply operating income over the past 12 months divided by sales over the same period, indicates how well a company is controlling its operating expenses. If a company has a high operating profit margin in relation to its competitors, it is doing a better job at controlling operating expenses.
All these ratios can be considered as effective measures if one compares different companies within a particular sector or industry. This is the reason why we have considered only those companies that have higher ratios than their respective industry averages.
In addition to the abovementioned ratios, we have added a favorable Zacks Rank #1 (Strong Buy) or 2 (Buy) to the screen with an objective to make this strategy more profitable.
Inventory Turnover, Receivables Turnover, Asset Utilization and Operating Margin greater than industry average
(Values of these ratios higher than industry averages may indicate that the efficiency level of the company is higher than its peers.)
The use of these few criteria has narrowed down the universe of over 7,906 stocks to only 19.
Here are four stocks from the 19 that made it through the screen:
Illumina (NASDAQ:ILMN) provides sequencing and array-based solutions for genetic analysis. The company has an average four-quarter positive earnings surprise of 23.2%. The stock sports a Zacks Rank #1.
Lululemon (NASDAQ:LULU), an athletic apparel company, together with its subsidiaries, designs, distributes, and retails athletic apparel and accessories for women, men, and female youth. The company has a Zacks Rank #1. The company has an average four-quarter positive earnings surprise of 10.9%.
Surmodics (NASDAQ:SRDX) provides medical devices and in-vitro diagnostic technologies to the healthcare industry in the United States and Ireland. The company has a Zacks Rank #2. The company has an average four-quarter positive earnings surprise of more than 100%.
ConocoPhillips (NYSE:COP) explores, produces, transports, and markets crude oil, bitumen, natural gas, liquefied natural gas (LNG) and natural gas liquids worldwide. The company has a Zacks Rank #2. The company has an average four-quarter positive earnings surprise of 226.9%.
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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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