Companies with favorable efficiency levels are likely to be on investors’ radar irrespective of market conditions. This is because 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.

Efficiency, which is the ability to transform inputs into outputs, is a potential indicator of a company’s financial health.

Key Ratios to Identify Efficiency

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

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. 

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.

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 Parameters

In addition to the above-mentioned ratios, we have added a favorable Zacks Rank #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 (Strong Buy) 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.)    

The use of these few criteria 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:

Vertex Pharmaceuticals Incorporated (VRTX - Free Report) is engaged in discovering, developing, manufacturing and commercializing medicines for serious diseases. This company has an average four-quarter positive earnings surprise of 17.9%.

Lululemon Athletica inc. (LULU - Free Report) is a designer, distributor, and retailer of athletic apparel. The company operates through two segments: Company-operated stores and Direct to consumer. It has an average four-quarter positive earnings surprise of 8.5%.

Sanderson Farms, Inc. (SAFM - Free Report) is an integrated poultry processing company, produces, processes, markets, and distributes fresh, frozen, and prepared chicken products in the United States. The company has an average four-quarter positive earnings surprise of 14%.

Farmers & Merchants Bancorp Inc (FMAO - Free Report) operates as a bank holding company for The Farmers & Merchants State Bank that provides commercial banking, retail banking, and other financial services to individuals and small businesses in northwest Ohio and northeast Indiana. The company has an average four-quarter positive earnings surprise of 4.9%.