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Disclaimer: This communication is provided for information purposes only and is not intended as a recommendation or a solicitation to buy, sell or hold any investment product. Readers are solely responsible for their own investment decisions.
In our journey to building a strong stock portfolio, we need to assess the health of the companies we consider investing in. Today's lesson focuses on a key financial metric: the Current Ratio.
Current Ratio interchangeable terms
Not to be mistaken with Quick Ratio, Current Ratio may also be referred to as:
Working Capital ratio
Liquidity Ratio
Current Ratio Formula
Current Ratio = Current Assets / Current Liabilities
Why is Current Ratio important?
Imagine your company is like a household. The Current Ratio tells you how well-equipped you are to handle your short-term bills. It's calculated by dividing current assets (cash, inventory, receivables) by current liabilities (short-term debts like accounts payable).
Aim for companies with Current Ratio of 1.5 to 2.
A ratio below 1 raises concerns. It suggests the company might struggle to pay its immediate bills. Conversely, a ratio above 2 could indicate the company isn't efficiently using its resources, potentially holding too much cash or inventory instead of investing in growth.
A Current Ratio between 1.5 and 2 is generally considered a sweet spot [1] .
It indicates the company has:
Enough liquidity to meet its short-term obligations comfortably.
Some buffer to handle unexpected challenges or economic downturns.
Where can you find Companies' Current Ratios?
Instead of having to manually calculate the Quick Ratios for the companies you are interested in analysing,
you can find them for free on sites like StockAnalysis.com.
Search for your companies, look for "Current Ratio" under Financials > Ratios.
Example of company where Current Ratio is between 1.5 & 2.
Tesla's Current Ratios were mostly between 1.5 & 2 since 2020
Example of company where Current Ratio is less than 1.
BYD's Current Ratio has been below 1 since 2021.
Conclusion
Remember, the Current Ratio is just one piece of the puzzle. While a 1.5 to 2 ratio is a good starting point, combine it with other financial analysis and your own research before making any investment decisions. Stay tuned for our next lesson, where we'll explore more tools to help you build a winning portfolio!
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