Trying to pick stocks in these crazy times is way more complicated than usual. All of a sudden, corporate liquidity becomes a big factor. In this article, we’ll explain how to measure it and highlight some of the most liquid companies on BUX X.
🙄 Investing in lean times
When the economy is booming, we tend to look for stocks with big profits, positive cash flows, and maybe a nice dividend. If they seem undervalued, then even better.
But when you’re facing a global recession, you can’t be so picky. In these crisis times, profits dry up or even turn to losses. Cash flows decrease and companies slash their dividends. Choosing a stock based on profit estimates becomes tricky (especially in a crisis when the numbers are impossible to predict). And picking a company based on historic dividends doesn’t make much sense either.
🤑 The importance of liquidity
What matters during a recession is cash. In times like these, companies might see lower demand for their products and services and they might have big debts to pay. Suddenly, having enough cash on hand is crucial.
This is the definition of liquidity. Being able to meet your demands without having to beg for new financing. And in times of crisis, it’s one of the most important things to look for in a company.
🌡️ How liquidity is measured
The most common way to measure liquidity is by using publicly available balance ratios. Specifically, the ‘current ratio’ and the ‘quick ratio’. Let’s explain…
This is the relationship between the company’s short-term assets and debts (or liabilities). By short-term assets, we mean cash and anything else that can be quickly sold for cash within a year, like securities, trade receivables and warehouse reserves. Short-term liabilities are all the debts the company has to pay in the next year.
If the current ratio is less than 1, it means the company has more short-term debt than cash. In other words, it doesn’t have enough liquidity to pay its debts for the next year. In a recession scenario, when cash flow drops, this can lead to financial problems for the company. So it’s wise to pick a company with a current ratio higher than 1.
The quick ratio is similar but it doesn’t take inventory into account. So it’s only based on the assets that can be liquidated quickly (cash + liquid securities + short-term credits) as a ratio to short-term debts.
A quick ratio higher than 1 tells you the company can cope with next year’s debts without selling any inventory. In short, it’s even better than using a current ratio. So that’s what we’ve used to find the most liquid companies on BUX X.
🏆 The 10 most liquid companies on BUX X
And here’s what you’ve been waiting for. Below are the ten companies with the best quick ratio currently on BUX X*.
Before you go, however, remember that liquidity isn’t the only factor to consider before investing. Some of the companies above may have some unattractive features in a recession period. They could still be overvalued based on one or more valuation metrics, or they could have negative cash flow. So always do your research before investing.
*As of 01/04/2020.