A company with a favorable efficiency level is expected to provide stellar returns as it is believed to be positively correlated with price performance. In fact, efficiency level, which measures a company’s capability to transform available input into output, is often considered an important parameter for gauging a company’s potential to make profits.

However, at times it becomes difficult to measure the efficiency level of a company. This is why one must consider popular efficiency ratios while selecting stocks. These efficiency ratios are:

Receivables Turnover:  This is the ratio of 12-month sales to four-quarter average receivables. It shows a company’s potential to extend its credit and collect debt in terms of that credit. A high receivables turnover ratio or the “accounts receivable turnover ratio” or “debtor’s turnover ratio” is desirable as it shows that the company is capable of collecting its accounts receivables or that it has quality customers.

Asset Utilization: This ratio indicates a company’s capability to convert assets into output and is thus a widely known measure of efficiency level. It is calculated by dividing total sales over the past 12 months by the last four-quarter average of total assets. Like the above ratios, high asset utilization may indicate that a company is efficient.

Inventory Turnover: The ratio of 12-month cost of goods sold (COGS) to a four-quarter average inventory is considered one of the most popular efficiency ratios. It indicates a company’s ability to maintain a suitable inventory position. While a high value indicates that the company has a relatively low level of inventory compared to COGS, a low value indicates that the company is facing declining sales, which resulted in excess inventory.

Operating Margin: This efficiency measure is the ratio of operating income over the past 12 months to sales over the same period. It measures a company’s ability to control operating expenses. Hence, a high value of the ratio may indicate that the company manages its operating expenses more efficiently than its peers.

Screening Criteria

In addition to the above-mentioned ratios, we have added a favorable Zacks Rank — Zacks Rank #1 (Strong Buy) or 2 (Buy) — to the screen with an objective to make this strategy more profitable. You can see the complete list of today’s Zacks #1 Rank stocks here.

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.)