The quick ratio helps investors figure out a company's capacity to pay its current liabilities without the need to sell its inventory and without additional financing. The quick ratio is a more conservative measure than the current ratio, as it does not include inventory (an "illiquid" current asset) in the calculation.
How can I use the quick ratio when investing in equities?
- You use the quick ratio to understand the company's liquidity position and its ability to pay off its short-term obligations, given its most liquid assets such as cash, marketable securities, and accounts receivable. It can help you understand a company's financial health. For example, Johnson and Johnson has a quick ratio of 1.01. In contrast, Procter & Gamble has a quick ratio of 0.68, which shows that although Johnson and Johnson are better able to meet its short-term obligations with its more liquid assets, suggesting that Johnson and Johnson could be the better investment option.
- However, as the quick ratio only shows a snapshot of the firm's liquidity status at a point in time, it does not show how the firm's liquidity has progressed over the years. For example, Johnson and Johnson's quick ratio decreased over the past five years, while Amazon's quick ratio increased, indicating that even though Amazon's liquidity was lacking in the past, it seems to be improving and could be a sign of a stock with high potential upside.
- Furthermore, when comparing quick ratios to determine which stock is a better long opportunity, it's a good idea to compare stocks within the same industry, as stocks from different industries may have different credit periods. In industries where it is typical to extend credits for 90 days or longer, companies may have lower quick ratios compared to those from industries where short-term collections are critical.
Debt to Equity Ratio
Used to evaluate a company's financial leverage and is calculated by dividing a company's total liabilities by its shareholder equity.
Profit is the financial benefit realized when revenue from a business is higher than the costs and taxes involved in operating that business.
Alternative investment class composed of funds that invest directly in private companies or that buy public companies and take them private
Time of declining economic activity, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and sales.
A stimulus package is a coordinated effort by the government to increase spending and investment to "stimulate" an economy out of a downturn.
Shorting a stock
Trading strategy that tries to take advantage of the decline in a stock price by borrowing a stock and sell it now while planning to repurchase it later for a lower price.
Market-capitalization-weighted index tracking the performance of the 500 largest U.S. companies