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. Which industries tend to have the most inventory turnover?

    Understand what inventory turnover measures and why it is good to have high inventory turnover. Learn what industries tend ... Read Answer >>
  2. 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 >>
  3. How can an investor determine the efficiency of a company's working capital management?

    Learn how working capital is vital to a company’s survival and key metrics investors use to assess how efficiently a company ... Read Answer >>
  4. How should I use portfolio turnover to evaluate a mutual fund?

    Learn about the turnover rate for mutual funds, and understand the effect higher turnover may have on fund performance and ... Read Answer >>
  5. What is a good turnover ratio for a mutual fund?

    Learn about mutual fund turnover ratios and why the ideal ratio may differ based on the type of mutual fund and your investment ... Read Answer >>
  6. How can a company raise its asset turnover ratio?

    Find out more about the asset turnover ratio, what it measures, how to calculate the ratio and how a company could increase ... Read Answer >>
Related Articles
  1. Investing

    Measuring Company Efficiency To Maximize Profits

    Efficiency ratios can provide indications of profitability, shows how efficiently a company is being managed, utilizes its assets and handles liabilities.
  2. Investing

    Dynamic Current Ratio: What It Is And How To Use It

    Learn why this ratio may be a good alternative to the current, cash and quick ratios.
  3. Investing

    Understanding Periodic vs. Perpetual Inventory

    An overview of the two primary inventory accounting systems.
  4. Investing

    Key Financial Ratios to Analyze The Auto Industry

    Learn about the most critically important financial ratios investors and market analysts utilize to evaluate companies in the automotive industry.
  5. Investing

    U.S. Crude Oil Inventories Up (XOM)

    U.S. crude oil inventories are at “historically high levels” for this time of the year, according to the Energy and Information Administration.
  6. Investing

    Asset Turnover Ratio

    Investopedia explains: The asset turnover ratio is a measure of a company's ability to use its assets to generate sales or revenue, and is a calculation of the amount of sales or revenue generated ...
RELATED TERMS
  1. Inventory Turnover

    Inventory turnover is a ratio showing how many times a company ...
  2. Working Capital Turnover

    Working capital turnover is a measurement comparing the depletion ...
  3. Perpetual Inventory

    Perpetual inventory is a method of accounting for inventory that ...
  4. Turnover Ratio

    Turnover ratio depicts how much of a portfolio has been replaced ...
  5. Carrying Cost Of Inventory

    Carrying cost of inventory, or carry cost, often refers to a ...
  6. Business Inventories

    Business inventories is an economic figure that tracks the dollar ...
Trading Center