Stock Investing Managers

Three simple tools clue us into managerial effectiveness. They center on the efficiency of inventory and receivables management and the thickness of profit margins. Some companies report the speed of inventory and receivable turns and the levels of profit margins directly in their periodic reports, and some even highlight this in the chairman's letters—usually signs of good or at least honest management. In other cases, you have to dig for it (not a good sign). Putting managers under the microscope this way helps gauge the prospects for future business performance—whether the maximal profits are being squeezed from the business or whether there is room for more.

Inventory Turns

While inventory is considered a current asset in that it is expected to be realized in cash within one year, you can be more precise about its relative liquidity by measuring the speed of its sale. Inventory speed, or turns, is measured by the relationship between the cost of goods sold (COGS) during a period and the average level of inventory during that period:

Current year's cost of goods sold (Beginning inventory + ending inventory)/2

Inventory turn levels are reliable indicators of the quality of inventory management. The longer inventory sits around without being sold, the less value it adds to the business, since it could be converted into cash deployed for more productive uses. High inventory levels also increase the risk of obsolescence or spoilage, require large amounts of either cash or bank borrowing to finance, and pose the risk of loss if the stock market price at which they can be sold declines materially.

GE is well known for its inventory turn management, and its long-time CEO, Jack Welch, regularly reports this in his annual letters. GE boasts inventory turns of a robust 8 amid a conglomerate average inventory turn of about 7 though shy of the S&P 500 average inventory turn of about 10. Microsoft stock investing manages inventory well too, right along with the rest of the computer industry, with turns of about 15; this is larger than GE in part because of the vastly different products these businesses sell.

But Amazon.com is superefficient in inventory management, at a breakneck pace of around 20. Amazon.com is a specialist in just-in-time inventory, a key management strategy developed in the last couple of decades that Amazon.com has taken to new levels. Stock investing doesn't sit idle in Amazon.com's warehouses, and this swift turnover lowers costs. That enables the business either to charge lower prices to its customers (hence Amazon.com's aggressive pricing discounts) or to continue to charge the stock market price but generate more stock market profit.

Receivable Turns

A company's credit policies can be its Achilles' heel or a driver of efficiency. Too many sales on credit or too many delinquencies or uncollectible accounts can crush cash flows. Speedy collection en­hances liquidity and can enable a company to get its customers to finance its business. Receivable turns are measured by credit sales (or total sales if those sales are not broken out separately) during a period divided by the average accounts receivable outstanding during the period:

Credit sales (Beginning accounts receivable + ending accounts receivable)/ 2

To gauge the speed of receivables collection, in turn, divide the number of days in a year by the number of turns. The result gives the average number of days the receivables are outstanding. Compare that average to the business's credit policies to see how well managers are running the credit part of the business. There is trouble if the average is greater than the policy (say, collections average 70 days but billing calls for payments to be made within 30 or 60 days).

GE displays considerable skill in receivables management, turning them about eight times per year, meaning they are collected on average within 45 days. That compares dramatically well to a conglomerate industry average of three turns, or 120 days. Microsoft is also a speedy collector, turning receivables about 11 times a year, or just over 30 days—perhaps as a result of its no-paper policy under which all bills (and invoices) are completed electronically—routing a slower computer industry average that looks more like that of GE (about eight turns, averaging 45 days).

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Again, the exceptional case is Amazon.com, a standout in this category, with about forty turns, or a mere nine days outstanding. That means Amazon.com's customers are funding a substantial part of Amazon.com's operations! They provide funds well ahead of the company's obligations to pay its creditors, particularly its suppliers, whose trade terms extend up to 60 days.