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.
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.
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.
Find out how to calculate the current ratio and what that result can tell you about a potential investment.
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