Inventory Turnover Ratio

Inventory turnover is a ratio that shows how many times a business has sold and replaced inventory during a given period. A company can use the inventory turnover formula to figure out how many the days it takes to sell the inventory on hand. Calculating this ratio helps businesses make better decisions on pricing, manufacturing, marketing, and purchasing new inventory.

How can I use the inventory turnover ratio when investing in stocks?

• You can use it to gauge a company’s sales and subsequently its stock price. A higher ratio implies that the company is experiencing strong sales as or low inventory due to a growing demand that its supply is not able to meet. This could lead to a rise in the stock price as investors push up not only the buying demand of the company’s goods but also its stocks. However, in the long-term, a high turnover ratio may have its limitations as a prolonged period of shortage of goods may lead to a loss in sales opportunity for the company. Companies with a high turnover ratio are usually from the fast fashion business as they typically limit runs and replace depleted inventory quickly with new items as new trends come and go fast.
• Conversely, a lower ratio implies weak sales and possibly excess inventory that may drive sales and prices down. Similar to the significant dip in oil prices at the beginning of the year due to low demand and excess supply of oil, company stocks may fall if their sales figures do not meet expectations. A lower ratio also implies that the inventory that stays for too long tends to depreciate, and this may negatively affect the company’s bottom line and subsequently, its stock price.

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