Among companies trading on the New York Stock Exchange and the Nasdaq, information technology companies offer high growth potential. Two technology companies, NXP Semiconductors NV (NXPI, Financial) and NVIDIA Corp. (NVDA, Financial), have strong current and Sloan ratios. As these companies have high profitability, several gurus poured capital into tech companies during the past quarter.
Three ratios that determine asset efficiency and earnings quality
Unlike the cash conversion cycle (CCC), which is a function of three days ratios, the current ratio is simply the total current assets (TCA) over the total current liabilities (TCL). However, the current ratio can still give a sense of how efficient a company turns its products into cash on hand. Healthy current ratios generally fall between 1 and 3: if a company’s TCA is less than its TCL, the company would not be able to pay off the liabilities. This can lead to issuance of debt. On the other hand, companies with current ratios over 3 likely have an unbalanced ratio between current assets and current liabilities. This usually occurs due to inefficient working capital management. The quick ratio is similar to the current ratio, but excludes the company’s inventory. Companies with increasing quick ratios usually have higher liquidity, and thus lower days inventory and CCCs.
The distribution of average current ratios across industries is slightly right-skewed with a median around 2. Over 75% of industries have average current ratios within the “healthy range” of 1 to 3. The distribution of average quick ratios across industries is slightly narrower than that of average current ratios, and the median average quick ratio is near 1.5.
While it does not directly measure the company’s efficient use of current assets, the Sloan ratio gives key information about the quality of a company’s earnings. University of Michigan professor Richard Sloan researched the “accrual anomaly,” a phenomenon that suggests that companies with minimal accruals outperform those with high accruals. The magnitude, or absolute value, of the Sloan ratio determines how likely a company’s earnings are made up of accruals. The “zones of discrimination” are as follows:
- If the magnitude of the Sloan ratio is less than 10%, the company’s earnings are generally pristine and accrual free.
- If the magnitude of the Sloan ratio is between 10% to 25%, the company’s earnings are becoming marred with accruals.
- If the magnitude of the Sloan ratio is over 25% throughout several quarters or years, the company’s earnings are most likely accrual-based. This is a potential warning sign.
The distribution of average Sloan ratios across industries is roughly symmetric with a median near 1.5. About 70% of the industries have an average Sloan ratio between -4% and 4%, well within safe, pristine zones.
Semiconductors have good current and Sloan ratios
The “Currently Profitable Sloans” screener lists the companies that meet the following criteria:
- First off, this screener only considers companies with a market cap greater than $5 billion.
- The company has a profitability rank of at least 7.
- The company’s current ratio is between 1 and 3, and its Sloan ratio is between -4% and 4%.
- The company’s operating margin growth rate is at least 4%.
During the backtesting period from 2006-2016, the Currently Profitable Sloans investing strategy generated an overall return of 130.93% using annual rebalancing and up to 30 stocks ranked by decreasing current ratios. While the test portfolio did not buy NXP Semiconductors or NVIDIA, both semiconductor companies made the screener list.
Despite having a modest financial strength rank, NXP still has a good Piotroski F-score of 6. The company’s current ratio and quick ratio ranks higher than 42% and 40% of global semiconductor companies, respectively. The company’s quarterly Sloan ratios seldom had a magnitude higher than 8 during the past three years, and its current Sloan ratio is -0.89%.
NVIDIA has higher financial strength and profitability than does NXP. Unlike NXP, whose Altman Z-score is currently in distressed zones, NVIDIA has a Z-score that implies almost no distress. The visual computing company has slightly stronger F-scores than does NXP.
NVIDIA has current and quick ratios near 10-year highs, likely reasons for high financial strength. The company’s operating margin currently outperforms 89% of global semiconductor companies, and has generally expanded since 2010.
As the company has high growth potential, five gurus have invested in NVIDIA during the past six months. Spiros Segalas (Trades, Portfolio) purchased 2,112,239 shares, the largest purchase among these gurus. The other four gurus purchased the following number of shares:
- Stanley Druckenmiller (Trades, Portfolio): 320,000 shares
- George Soros (Trades, Portfolio): 163,322 shares
- Caxton Associates (Trades, Portfolio): 50,000 shares
- Ken Heebner (Trades, Portfolio): 40,000 shares
Soros also invested 48,446 shares in NXP Semiconductors, and Ken Fisher (Trades, Portfolio) added 40.38% to his NXP stake.
See also
For more good guru picks in the technology sector, you can view Sector Picks, Consensus Picks and Most Active Picks. Additionally, you can see the top 10 stock holdings of gurus. Premium members have access to all the value screeners, including the Undervalued Predictable and Buffett-Munger Screeners. Additionally, the premium membership includes access to the monthly Buffett-Munger Newsletter, the Manual of Stocks for companies trading on the Standard & Poor’s 500 index, real-time guru picks and insider trends. The premium plus membership gives further access, including the Manual of Stocks for all U.S. companies and up to 10-years of backtesting and 20,000 monthly queries in the Excel Add-in and API. Please review the membership benefits and sign up for a free seven-day trial.
Disclosure: The author has no position in any stock mentioned.
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