Investors seeking strong returns may allocate their assets in stocks with favorable liquidity positions. 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 always has the potential to provide 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 compared to peers, 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.
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 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 using cash.
So, a ratio greater than 1 is desirable at all times but may not always reflect the condition of a company’s financial health.
Screening Parameters
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 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 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 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:
Tampa, FL-based WellCare Health Plans Inc. WCG is a leading managed care company. It primarily focuses on providing government-sponsored managed care services. The company has a Growth Style Score of A and an average four-quarter positive earnings surprise of 64.34%. Moreover, the Zacks Consensus Estimate for 2017 earnings has climbed by $1.03 per share to $8.04 over the last 30 days.
The Boston Beer Company Inc. SAM, based in Boston, MA, is among the leading craft brewers in the domestic market. The company has a Growth Style Score of B and an average four-quarter positive earnings surprise of 63.35%. The Zacks Consensus Estimate for 2017 earnings has risen by 51 cents a share to $6.08 over the last 30 days.
San Jose, CA-based Adobe Systems Inc. ADBE is one of the largest software companies in the world. The company has a Growth Style Score of B and an average four-quarter positive earnings surprise of 7.80%. The Zacks Consensus Estimate for 2017 earnings has remained steady at $4.20 per share over the last 30 days.
Based in New York City, Take Two Interactive Software Inc TTWO is a leading developer and publisher of video games and peripherals. The company has a Growth Style Score of B and an average four-quarter positive earnings surprise of 107.07%. The Zacks Consensus Estimate for 2017 earnings has increased by a couple of cents to $2.21 per share over 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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