A Hidden Reason That LTX-Credence's Earnings Are Outstanding

It takes money to make money. Most investors know that, but with business media so focused on the "how much," very few investors bother to ask "how fast?"

When judging a company's prospects, how quickly it makes real cash money can be just as important as how much it's currently generating in the accounting fantasy world we call "earnings." It's one of the first metrics I check when I'm hunting for the market's best stocks. Today, we'll see how it applies to LTX-Credence (Nasdaq: LTXC  ) .

Let's break this down
To measure how swiftly a company turns cash into goods or services and back into cash, we'll lean on a quick, relatively foolproof metric known as the cash conversion cycle, or CCC for short.

Why does the CCC matter? The less time it takes a company to convert outgoing cash into incoming cash, the more powerful and flexible the profit engine is. The less money tied up in inventory and accounts receivable, the more that's available to grow the company, pay investors, or both.

To calculate the cash conversion cycle, add days inventory outstanding (DIO) to days sales outstanding (DSO) and then subtract days payable outstanding (DPO). As in golf, the lower your score here, the better.

Here's the CCC for LTX-Credence, alongside the comparable figures from a few competitors and companies across the larger semiconductor equipment industry.

Company

TTM Revenue

TTM CCC

LTX-Credence $260  84
Teradyne (NYSE: TER  ) $1,666  50
FormFactor (Nasdaq: FORM  ) $189  62
Advantest (NYSE: ATE  ) $1,202  138

Source: Capital IQ, a division of Standard & Poor's. Dollar amounts in millions. Data is current as of last fully reported fiscal quarter. TTM = trailing 12 months.

For younger, fast-growth companies, the CCC can give you valuable insight into the sustainability of the growth. A company that's taking longer to make cash may need to tap financing to keep its momentum. For older, mature companies, the CCC can tell you how well the company is managed. Companies that begin to lose control of the CCC may be losing their clout with their suppliers (who might be demanding stricter payment terms) and customers (who might be demanding more generous terms). This can sometimes be an important signal of future distress -- one most investors are likely to miss.

Although I find peer comparisons to be useful, I’m most interested in comparing a company's CCC with its past performance. Here's where I believe all investors need to become trend-watchers. Sure, there may be legitimate reasons for an increase in the CCC, but all things being equal, I want to see this number stay steady or move downward over time.

Source: Capital IQ, a division of Standard & Poor's. Dollar amounts in millions. FY = fiscal year. TTM = trailing 12 months.

Because of the seasonality in some businesses, the CCC for the TTM period may not be strictly comparable with the fiscal-year periods shown the chart. Even the steadiest-looking businesses on an annual basis will experience some quarterly fluctuations in the CCC. To get an understanding of the usual ebb and flow at LTX-Credence, consult the following quarterly-period chart.

Source: Capital IQ, a division of Standard & Poor's. Dollar amounts in millions. FQ = fiscal quarter.

On a 12-month basis, the trend at LTX-Credence looks very good. At 83.6 days, it is 17.5 days better than the five-year average of 101.1 days. The biggest contributor to that improvement was DIO, which improved 29.6 days compared with the five-year average. That was partially offset by a 17.6-day increase in DPO.

Considering the numbers on a quarterly basis, the CCC trend at LTX-Credence looks good. At 85.5 days, it is little changed from the average of the past eight quarters. With both 12-month and quarterly CCC running better than average, LTX-Credence gets high marks in this cash-conversion checkup.

Though the CCC can take a little work to calculate, it's definitely worth watching every quarter. You'll be better informed about potential problems, and you'll improve your odds of finding the underappreciated home-run stocks that provide the market's best returns.

To stay on top of the CCC for your favorite companies, just use the handy links below to add companies to your free watchlist.

Seth Jayson had no position in any company mentioned here at the time of publication. You can view his stock holdings. He is a co-advisor of Motley Fool Hidden Gems, which provides new small-cap ideas every month, backed by a real-money portfolio. The Motley Fool owns shares of FormFactor, and Motley Fool newsletter services have recommended buying shares of and creating a bull call spread position in FormFactor. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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