Efficiency is a great thing for cars, lightbulbs, and washing machines. After all, you want to make sure that your mechanical servants are using energy wisely. It's also a desirable quality in corporate finance, as a company's ability to efficiently deploy its inventory and capital can be a signal that it is able to wring the greatest amount of profit out of its operations.
How can you measure a company's financial efficiency? We built our latest screen by searching for companies that scored in the highest 20% in their respective industries in three key metrics:
Receivables turnover: The average duration of an account receivable, equal to total credit sales, divided by accounts receivable. Basically, it's an indication of how fast a company is getting paid by customers to whom it extends credit.
Inventory turnover: The ratio of annual sales to inventory, which essentially measures the fraction of a year that an average item remains in inventory. Low turnover is a sign of inefficiency, since inventory usually has a rate of return of zero. The higher the ratio, the better.
Return on equity: This is a company's after-tax income for a fiscal year (after preferred stock dividends, but before common stock dividends) divided by book value, expressed as a percentage. This is a widely followed efficiency indicator, since it signals how much profit a company is able to generate given the resources provided by stockholders.
High efficiency is nice, but we took a couple of extra steps to refine our list to the most attractive names. So we next screened for those stocks with top scores under Standard & Poor's Stock Appreciation Ranking System (STARS), a qualitative stock ranking system based on fundamental research conducted by S&P's own equity analysts. We sifted our database for the list of companies ranked 4-STARS (buy) or 5-STARS (strong buy), meaning that S&P analysts expect them to outperform the S&P 500 index over the coming 12 months on a total return basis, with the shares rising in price on an absolute basis.
In addition, each stock had to have a per-share price above $5 and a market capitalization greater than $1 billion.
When we finished our search, eight names emerged:
|MEMC Electronics Materials||WFR||$57.10|