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. What is the formula for calculating inventory turnover?

    The inventory turnover ratio is an important efficiency metric, especially for those in retail. This ratio compares the amount ... Read Full Answer >>
  2. How can Economic Order Quantity be used to lower inventory costs?

    Economic order quantity determines the optimal number of units a company should hold in its inventory. It determines the ... Read Full Answer >>
  3. Why is it sometimes better to use an average inventory figure when calculating the ...

    Inventory turnover is an important metric for evaluating how efficiently a firm turns its inventory into sales. For a couple ... Read Full Answer >>
  4. How do I calculate the inventory turnover ratio?

    Managing inventory levels is important for most businesses and this is especially true for retailers and any company that ... Read Full Answer >>
  5. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  6. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>
Related Articles
  1. Fundamental Analysis

    Inventory: FIFO, LIFO

    Whether a company chooses FIFO or LIFO has important implications for the bottom line and for tax liability.
  2. Mutual Funds & ETFs

    ETF Analysis: iShares Morningstar Small-Cap Value

    Find out about the Shares Morningstar Small-Cap Value ETF, and learn detailed information about this exchange-traded fund that focuses on small-cap equities.
  3. Mutual Funds & ETFs

    ETF Analysis: WisdomTree SmallCap Earnings

    Discover the WisdomTree Small Cap Earnings ETF, a fund with a special focus on small-cap and micro-cap stocks with positive earnings.
  4. Mutual Funds & ETFs

    ETF Analysis: iShares US Regional Banks

    Obtain information and analysis of the iShares US Regional Banks ETF for investors seeking particular exposure to regional bank stocks.
  5. Technical Indicators

    Key Financial Ratios to Analyze the Mining Industry

    Discover some the most important financial ratios used by investors and analysts to evaluate companies in the metals and mining industry.
  6. Technical Indicators

    Key Financial Ratios to Analyze Retail Banks

    Learn about key financial metrics that investors use to evaluate retail banks, and how the industry is fundamentally different from most other industries.
  7. Technical Indicators

    Key Financial Ratios to Analyze Airline Companies

    Examine some of the most important financial ratios and performance metrics investors use to evaluate companies in the airline industry.
  8. Stock Analysis

    The 5 Biggest Canadian Oil Companies

    Obtain information about some of the largest and most successful major integrated oil corporations that are headquartered in Canada.
  9. Technical Indicators

    Key Financial Ratios to Analyze Tech Companies

    Understand the technology industry and the companies that operate in it. Learn about the key financial ratios used to analyze tech companies.
  10. Stock Analysis

    3 Reasons to Continue to Own Monster Beverage

    Learn more about the Monster Beverage Corporation and some of the primary reasons why investors and market analysts like the stock.
RELATED TERMS
  1. Days Sales Of Inventory - DSI

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

    A calculation comparing the value or number of a particular good ...
  3. Profit Margin

    A category of ratios measuring profitability calculated as net ...
  4. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis ...
  5. Debt Ratio

    A financial ratio that measures the extent of a company’s or ...
  6. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing ...

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!