A:

Inventory turnover is an important metric for evaluating how efficiently a firm turns its inventory into sales. Below is a discussion of what a high turnover ratio says about a company.

What Inventory Turnover Tells Investors

Intuitively, it makes sense that a retailer that is able to turn over, or sell, its inventory more often than a rival is a better operator. This characteristic generally holds true.

To learn more, check out "How do I calculate the inventory turnover ratio?"

One academic study that was first published in 2011 but updated in 2013, suggests that stronger inventory turnover figures can lead to outperformance. The paper is called Does Inventory Productivity Predict Future Stock Returns? A Retailing Industry Perspective and it estimated that investing in a select basket of retailing firms with the highest inventory turnover ratios and selling, or shorting a select basket of those with the lowest turnover ratios, performed well ahead of an industry benchmark.

The article considers inventory turnover as a pure form of inventory productivity. It also noted that it is correlated with a higher gross margin and sales surprise, meaning that firms with higher inventory turnover can also be more profitable and report sales ahead of what analysts and investors originally project. For these reasons, it can be a sign of a competitive advantage.

Other Considerations

Another article in the Harvard Business Review is titled Retailers Beware: Markets Punish Stores with Too Much Inventory and it detailed that there are optimal levels of inventory and told the best way to move it through a company’s system. Too much inventory that is sold too slowly can be a detriment, and the reverse is also true. It also noted the difference between selling high profit inventory more slowly and lower margin goods more quickly, which can both be beneficial if the right balance is found.

The Bottom Line

Managing inventory levels is important for most businesses and this is especially true for retailers and any company that sells physical goods.

RELATED FAQS
  1. How do I calculate the inventory turnover ratio?

    The inventory turnover ratio is a key measure for evaluating how efficient management is at managing company inventory and ... Read Answer >>
  2. What is the formula for calculating inventory turnover?

    Learn about the inventory turnover ratio, how it is calculated and what this efficiency metric tells businesses about their ... Read Answer >>
  3. How do you analyze inventory on the balance sheet?

    Learn how to analyze inventory using financial statements and footnotes by doing ratio analysis and performing qualitative ... Read Answer >>
  4. What is the formula for calculating the inventory turnover ratio in Excel?

    Find out more about inventory turnover ratio and the formula for calculating a company's inventory turnover ratio using Microsoft ... Read Answer >>
  5. How does inventory turnover affect the cash conversion cycle (CCC)?

    Learn how a company's inventory turnover affects its cash conversion cycle (CCC). Understand why a higher inventory turnover ... Read Answer >>
  6. What are some examples of efficiency ratios used in measuring businesses?

    Learn about some of the most common efficiency ratios that market analysts and investors use in the process of evaluating ... Read Answer >>
Related Articles
  1. Investing

    Reading The Inventory Turnover

    Inventory turnover is a ratio that shows how quickly a company uses up its supply of goods over a given time frame. Inventory turnover may be calculated as the market value of sales divided by ...
  2. Investing

    AR & Inventory Turnover Is Key For These Sectors

    Accounts receivable and inventory turnover are two important ratios in the current asset category. We will also discuss the key industries that benefit from a thorough understanding of these ...
  3. Investing

    Days Sales of Inventory

    Days Sales of Inventory, also called Days Inventory Outstanding, is a key financial measurement of a company's performance pertaining to inventory management. In simple terms, it tells how many ...
  4. Investing

    How to Analyze a Company's Inventory

    Discover how to analyze a company's inventory by understanding different types of inventory and doing a quantitative and qualitative assessment of inventory.
  5. Investing

    Measuring Company Efficiency

    Three useful indicators for measuring a retail company's efficiency are its inventory turnaround times, its receivables and its collection period.
  6. Investing

    What is Involved in Inventory Management?

    Inventory management refers to the theories, functions and management skills involved in controlling an inventory.
  7. Managing Wealth

    Understanding Turnover

    Turnover has a number of different, but related, meanings depending on the context in which it is used. Generally, it means the number of times an item is replaced with a new or similar version ...
  8. Investing

    How to Calculate Average Inventory

    Average inventory is the median value of an inventory at a specific time period.
  9. Investing

    Key Financial Ratios for Retail Companies

    Using the following liquidity, profitability and debt ratios, an investor can gather deeper knowledge of a retail company's short-term and long-term outlook.
  10. Investing

    Inventory Valuation For Investors: FIFO And LIFO

    We go over these methods of calculating this component of the balance sheet, and how the choice affects the bottom line.
RELATED TERMS
  1. Days Sales Of Inventory - DSI

    A financial measure of a company's performance that gives investors ...
  2. Inventory Turnover

    Inventory Turnover is a ratio showing how many times a company's ...
  3. Average Inventory

    A calculation comparing the value or number of a particular good ...
  4. Average Age Of Inventory

    The average number of days it takes for a firm to sell to consumers ...
  5. Ending Inventory

    The value of goods available for sale at the end of the accounting ...
  6. Perpetual Inventory

    A method of accounting for inventory that records the sale or ...
Hot Definitions
  1. Expense Ratio

    A measure of what it costs an investment company to operate a mutual fund. An expense ratio is determined through an annual ...
  2. Pro Forma

    A Latin term meaning "for the sake of form". In the investing world, it describes a method of calculating financial results ...
  3. Trumpcare

    The American Health Care Act, also known as Trumpcare and Ryancare, is the Republican proposal to replace Obamacare.
  4. Free Carrier - FCA

    A trade term requiring the seller to deliver goods to a named airport, terminal, or other place where the carrier operates. ...
  5. Portable Alpha

    A strategy in which portfolio managers separate alpha from beta by investing in securities that differ from the market index ...
  6. Run Rate

    1. How the financial performance of a company would look if you were to extrapolate current results out over a certain period ...
Trading Center