Liquidity indicates a company’s capability of meeting its debt obligations by converting its assets into liquid cash and equivalents. Companies with a favorable liquidity position have always been in demand as they are believed to have the potential to boost portfolio returns.
However, one should be careful 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 may 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 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. Though this ratio varies across industries, companies with a ratio higher than their respective industries can be called efficient.
In order to ensure that these liquid and efficient stocks have solid growth potential too, 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.)
Just these few criteria have narrowed down the universe of over 7,700 stocks to only five.
Here is the list:
The Children's Place, Inc. PLCE is a specialty retailer of apparel and accessories for children from newborn to twelve years of age. Children's Place has a Growth Style Score of ‘A’ and an average four-quarter positive earnings surprise of 36.3%. The Zacks Consensus Estimate for 2017 earnings remained steady at $5.17 per share over the last 30 days.
The Children’s Place gained 52.7% in the last one year compared with the Zacks Retail- Apparel and Shoes industry’s decline of 13.4%.
Evercore Partners Inc. EVR is a leading investment banking boutique providing advisory services to prominent multinational corporations. The company has a Growth Style Score of ‘A’ and an average four-quarter positive earnings surprise of 15.7%. The Zacks Consensus Estimate for 2017 earnings increased 3.7% (16 cents) to $4.53 per share over the last 30 days.
Evercore’s one-year return of 71.5% is better than the Zacks Financial- Investment Bank industry’s gain of 13.2%.
Logitech International SA LOGI designs, manufactures and markets products that allow people to connect through music, gaming, video, computing, and other digital platforms. The company has a Growth Style Score of ‘A’ and an average four-quarter positive earnings surprise of 131.60%. Moreover, the Zacks Consensus Estimate for 2017 earnings increased 27.3% (24 cents) to $1.12 per share over the last 30 days.
Logitech’s one-year return of 71.5% is better than the Zacks Computer- Peripheral Equipment industry’s gain of 13.2%.
Zendesk Inc. ZEN provides a software-as-a-service, or SaaS, customer service platform. It provides customer service in a wide range of languages in various industries. Zendesk has a Growth Style score of ‘B’ and an average four-quarter positive earnings surprise of 12.7%. Further, the Zacks Consensus Estimate for 2017 has narrowed down to a loss 99 cents from $1.22 over the last 30 days.
Zendesk’s one-year return of 59.8% is better than the Zacks Internet Software industry’s gain of 20.4%.
McDermott International Inc. MDR is a provider of engineering, construction and module fabrication services for upstream field developments. The company has a Growth Style Score of ‘B’ and an average four-quarter positive earnings surprise of 474%. The Zacks Consensus Estimate for 2017 earnings increased 12.5% (2 cents) to 18 cents per share over the last 30 days.
McDermott’s one-year return of 221.3% is much better than the Zacks Oil and Gas - Mechanical and Equipment industry’s gain of 34.2%.
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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.
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