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How To Use Liquidity Ratios To Find Underperforming Stocks

|Includes: AN, BAMXF, BKS, CHCI, DXLG, FENX, FORK, GPI, HEAR, HOME, HOV, JRjr33, Inc. (JRJR), MNRO, PAG, PII, SAH, SHLDQ, TUP, VWAGY, ZAGG

Why should I care about my stock's Current Ratio or Inventory Turnover? What about its Cash Conversion Cycle or Cash Ratio?

In the article below, I explain why using liquidity ratios can help find struggling businesses that may be inefficiently managed and ultimately help increase stock returns.


Consumer Stocks With Poor Liquidity Ratios

I always found it frustrating in school when finance professors would define financial terms rather than show why I should care about them.

So to start, I'll show why investors should be considering their stock's liquidity ratios in order to help improve returns. I created this Poor Liquidity Stock Screen to find companies in the consumer discretionary sector that have below average liquidity ratios. The screen found the following 20 companies as of December 8th, 2017:

Consumer Stocks With Poor Liquidity
Ticker Name Current Ratio Inventory Turnover Cash Conversion Cycle Cash Ratio
JRJR JRjr33, Inc. 0.4x 6.5x 43 days 3.7%
AN AutoNation, Inc. 0.7x 6.2x 78 days 0.9%
HOME At Home Group 0.8x 3.5x 112 days 2.8%
HOV Hovnanian Enterprises 0.8x 1.9x 191 days 19.6%
SHLD Sears Holdings 0.9x 4.9x 78 days 8.9%
VLKAY Volkswagen AG 1.0x 5.5x 173 days 22.8%
TUP Tupperware Brands 1.0x 8.0x 127 days 18.7%
FENX Fenix Parts, Inc. 1.0x 3.9x 151 days 2.6%
MNRO Monro Muffler Brake 1.0x 7.5x 38 days 3.1%
BKS Barnes & Noble, Inc. 1.0x 4.0x 66 days 1.1%
BAMXF Bayerische Motoren Werke 1.0x 7.1x 147 days 22.6%
PAG Penske Automotive Group 1.0x 5.9x 77 days 0.8%
PII Polaris Industries Inc. 1.0x 6.5x 56 days 11.1%
GPI Group 1 Automotive, Inc. 1.0x 6.5x 64 days 3.1%
HEAR Turtle Beach Corp 1.1x 3.3x 106 days 0.7%
SAH Sonic Automotive, Inc. 1.1x 6.7x 72 days 0.8%
CHCI Comstock Holding 1.1x 1.0x 319 days 8.0%
ZAGG ZAGG Inc 1.1x 6.6x 62 days 6.9%
DXLG Destination XL Group 1.1x 3.9x 127 days 5.5%
FORK Fuling Global Inc. 1.1x 8.0x 68 days 17.5%

Okay, so the stocks above all have poor liquidity ratios. Why do we care?

Liquidity ratios measure the ability of a company to meet its short-term debt obligations implying that the companies listed above may be under financial duress. Therefore, you could reasonably expect that these businesses may be struggling which could lead to their stock prices underperforming.

I exported the stock screen to google sheets and used finbox.io's spreadsheet add-on to calculate each stock's 1-year return as of December 8th. I found that seventy-five percent (75%) of the stocks above underperformed the S&P 500 over the last year. Furthermore, six of the twenty stocks (30%) lost more than 45% of their value over the last year.

The performance of an equally weighted index of these 20 stocks compared the S&P 500 over the last year is shown below.

It's also important to note that at this time last year, all of the companies above would have made this poor liquidity list except for Polaris Industries and Fuling Global. Polaris Industries and Fuling Global were two of the outliers as their share prices actually increased by 55.4% and 44.0% over the last 52-weeks, respectively.

Continue reading How To Use Liquidity Ratios To Find Underperforming Stocks.