It may seem counter-intuitive, but low inventory levels tend to be a good sign, while high ones can be cause for concern. A high inventory level might make a company appear well positioned to meet demand, but it's risky: Demand may suddenly plunge. Indeed, a large inventory may signal that demand has already slackened.
Products end up sitting on the shelves all the time. Fashion trends change, technological advances make current products obsolete, and the functional utility of some products is gone after a certain time. A computer manufacturer with a large stock of older computers probably can't sell many of them because buyers want newer models. A warehouse full of Christmas ornaments in January faces similarly bleak prospects.
Anything left sitting on a warehouse shelf costs money to hold and risks not being sold. Efficient companies try to maintain low levels of inventory. These levels permit quick reaction to market changes and minimize the chances the company will get stuck with extra goods.
If you want to check out a company's inventory levels, look up its latest balance sheet -- you'll find inventories listed near the top, among assets. See how inventory levels have changed over recent quarters and years -- ideally, they shouldn't be growing any faster than sales.
You can learn more about how to evaluate companies in our highly regarded How-to Guides and online seminars. If you're interested in receiving a handful of promising stock ideas each month, consider subscribing to one of our stock recommendation newsletters.