Inventory includes the raw materials, work-in-process goods and completely finished goods of a company. It is a portion of a companys current assets.
Inventory control is an important part of business operation. If a company does not have enough inventory, it may not be able to meet customers required delivery time. If it has too much inventory, the cost of holding the inventory can be high.
In Ben Grahams calculation of liquidation value, inventory is only considered worth half of its book value:
Liquidation Value = Cash and short-term investments + (0.75 * accounts receivable) + (0.5 * inventory) - total liabilities
Inventory can be measured by Days Sales of Inventory (DSI):
Days Sales of Inventory (DSI) = Inventory /Revenue * Days in Period.
Manufacturers with durable competitive advantages have the advantage that the products they sell do not change, and therefore will never become obsolete. Buffett likes this advantage.
When identifying manufacturers with durable competitive advantage, look for inventory and net earnings that rise correspondingly. This indicates that the company is finding profitable ways to increase sales which called for an increase in inventory.
Manufacturers with inventories that spike up and down are indicative of competitive industries subject to boom and bust.
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