Inventory turnover is an important metric for evaluating how efficiently a firm converts inventory into sales. A retailer that is able to sell or turn over inventory more frequently than a rival would be considered to be a better operator.
What Inventory Turnover Tells Investors
A 2014 paper published in the journal Management Science found that stocks for companies with stronger inventory turnover figures outperformed their peers. The paper concluded that investing in a basket of retailers with the highest inventory turnover ratios, while shorting retailers with the lowest ratios, would perform well ahead of industry benchmarks.
The study viewed inventory turnover as a pure form of inventory productivity. A company with high inventory turnover was more likely to report better-than-expected gross margin and sales figures, and therefore report profit and sales figures ahead of market expectations. For these reasons, high inventory turnover was a sign of a competitive advantage.
Harvard Business Review contributed to the discussion by noting there were optimal levels of inventory that should move 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 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. (To learn more, check out, "How do I calculate the inventory turnover ratio?")