Companies with a high liquidity rating are often in hot demand on the stock markets, as these companies are believed to hold the most potential for maximising investor returns. Liquidity is not always an indicator of success, so investors should examine the company before choosing to purchase stock. In some cases, a high level of liquidity can point to the fact that a company is instead not making efficient use of its assets.
However, in many cases a high level of liquidity means that the business is meeting its obligations more efficiently and at a faster rate than the competition. In the PDF attachment you can find a definition of market liquidity. Lenn Mayhew Lewis is a shareholder and director of Core Capital Advisors, a proprietary trading firm focusing on the markets for exotic currencies.
Calculating Current Ratio
There are several ways to calculate the liquidity of a company’s stock, the first of which is the current ratio. This is calculated quite simply by dividing the current liabilities of the company into its current assets. If the current ratio is between one and three this is considered a good indicator that the company is healthy. A ratio of between one and three suggests that the company is liquid and is also making best use of its assets. Higher than three can point to under-utilisation of assets, while lower than one means the company has more debt obligations than it is able to meet in the current climate. The embedded short video looks at calculating asset utilisation to gain a clearer picture.
Calculating Acid-Test Ratio
The acid-test ratio measures the short-term ability of the organisation to pay debts. In this calculation, assets that are fairly illiquid such as inventory are discounted. The acid-test ratio uses only liquid assets – which are cash, cash equivalents, short-term investments and accounts receivable – when dividing by liabilities. A slightly simpler variation of the acid-test ratio can be reached by simply taking away inventory from the current assets before dividing, which naturally gives a slightly more generous result. Just as with the current ratio calculation, a score of one or more is what investors want to see.
Calculating Cash Ratio
The cash ratio calculation is the most exacting or conservative ratio of liquidity, as only cash, cash equivalents and short-term investments are divided by current liabilities. This gives a more accurate picture of the ability of the company to fully meet its debt obligations even in a situation of emergency. As with the current ratio, a score greater than one is what investors want to see, but a score that is too high can represent under-utilisation of cash rather than sound financials.
Growth traders are those that primarily focus their trades on stocks in companies that have demonstrated potential or actual aggressive revenue and earnings growth, which should mean the price of those stocks will be propelled even higher in the future. Many companies in this category are smaller-cap businesses towards the beginning of their growth cycle, although that’s not to say there aren’t plenty of large-cap and mid-cap companies in there too. However, stocks with the highest possible growth rates are not necessarily a good bet in growth trading, as these levels of growth are unsustainable and therefore such companies can go on to underperform.
In the infographic attachment you can see an overview of four of the best liquid stocks to invest in at the time of writing.