As investors, we’re buying into the future of a company and unless we’re shorting its shares (when we short a share, we’re betting that its price would fall), we would want to see the company’s business improve over time. If the company’s business worsens, we might then end up with a poor investment over the long-term. On that note, the analysis of a company’s inventory and accounts receivable – both are line items that can be found in a balance sheet – can give investors important clues about the future health of a company. What to look out…
As investors, we’re buying into the future of a company and unless we’re shorting its shares (when we short a share, we’re betting that its price would fall), we would want to see the company’s business improve over time.
If the company’s business worsens, we might then end up with a poor investment over the long-term.
On that note, the analysis of a company’s inventory and accounts receivable – both are line items that can be found in a balance sheet – can give investors important clues about the future health of a company.
What to look out for
With these two figures, we’d ideally not want to see them grow faster than sales.
When it comes to a company’s inventory rising faster than sales, it could be a case of obsolete products or customer-demand which has come in much weaker than expected. I trust it’s obvious to see that both scenarios are certainly not welcome for investors.
As for accounts receivables growing at a faster clip than sales, it can be a sign of some serious business issues which are troubling a company. Here are a few: The company might have been forced to extend liberal credit terms to its customers in order to stay in business; the company might be having trouble collecting payments from customers (who might end up never paying); and/or the company’s forcing its products down the throats of its distributors at a faster rate than they are able to sell. The last scenario is also known as “channel stuffing.”
Keeping all the above in mind, here are three shares which have seen their inventories and accounts receivables grow at much faster rates than their revenues over the past few quarters:
1. Pacific Andes Resources Development Ltd (SGX: P11)
As you can see in the chart above, Pacific Andes, an integrated fish and fish products outfit, had revenue that was initially growing faster than its inventory and accounts receivable. But, the situation has since reversed over the last three quarters.
In its latest quarter, the company’s quarterly inventory and accounts receivable actually ballooned by 120% and 36%, respectively, despite revenue falling by 4.0%.
2. Challenger Technologies Limited (SGX: 573)
Next up we have Challenger Technologies, a purveyor of electronics and IT (information technology) products through its Challenger, Valore, and Musica brand of retail stores. In a similar fashion to Pacific Andes, Challenger Technologies’ revenue growth started out higher than that of its inventory and accounts receivable.
But in Challenger Technologies’ last three quarters, increases in inventory and accounts receivable have outstripped the same for revenue. In the latest quarter, the company’s year-on-year growth in revenue, inventory, and accounts receivable came in at -10%, -0.5%, and 30.2% respectively.
3. Maxi-Cash Financial Services Corp Ltd (SGX: 5UF)
Pawn-broker Maxi-Cash rounds up the trio here with a very significant increase in inventory over the last three quarters despite seeing non-existent revenue growth.
In its latest quarter, Maxi-Cash, which has 37 pawnshops across Singapore at the moment, saw its quarterly inventory spike up by 54% year-on-year despite revenue falling by 4%. Meanwhile, accounts receivable logged a 4.8% increase.
Foolish Bottom Line
It’s not always a bad thing for a company to see its inventory and accounts receivable grow faster than sales.
For instance, inventory-growth which outstrips sales-growth can actually be a good thing in one scenario. The inventory line item on the balance sheet is made up of three components: 1) Finished goods; 2) works-in-progress; and 3) raw materials. If the bulk of a company’s inventory increases comes in the form of a growth in raw materials, that’s the good thing we’re looking out for. That’s because a company would bulk up on raw materials mainly so that it can pump up its production – this could be a sign that the company’s starting to see more demand for its products and would need to meet that demand.
But in any case, when a company starts seeing its inventory and/or accounts receivable spike up harder than its sales – as it is with Pacific Andes, Challenger Technologies, and Maxi-Cash – investors ought to sit-up and take notice to make sure that its business is not heading in the wrong direction.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn’t own shares in any companies mentioned.