Profit From the Inventory Edge

The amount of inventory a company maintains can make a huge difference to its bottom line. If the warehouse shelves are too threadbare, customers won't be able to find the products they want, and they may just take a hike toward a competitor's offering. But if those shelves groan with products going unsold, the company will have to shell out money to house all those unwanted items, discount them in stores just to clear out space, and maybe even cut back production to reflect the sluggish sales.

To see whether any given company has its inventory under control, check its inventory turnover -- a company's cost of goods sold, divided by its average inventory. The resulting number reflects how quickly products are flying off the shelves -- or how much dust they may be gathering as they languish there. The faster inventory turns over, the more efficiently a company is in matching its production to its sales.

Shelf traffic
Depending on their business models, not all companies will have inventory levels to assess. Some investors flock to companies such as eBay (Nasdaq: EBAY) or Accenture (NYSE: ACN) because they sport little or no inventory, and none of the considerable costs associated with storing it. eBay makes its money from transactions without having to maintain any inventory of its own, while Accenture's primary revenue generators are its human consultants, not a physical product in a box.

However, many companies do deal with inventory, including the aluminum industry. Many Wall Street bulls think this sector will thrive once the global economy rebounds. Below, I've rounded up three of the top players in aluminum:

Source: Morningstar.

Looking only at the numbers above, relative pipsqueak Century Aluminum appears to be the best buy, with its inventory moving off shelves most rapidly. But Alcoa isn't that far behind, and its rate is rising, as opposed to Century Aluminum's modest slide.

Inventory issues to watch for
When assessing inventory, remember that a number's trend can be more important than its absolute value. Ideally, you want to see inventory turnover growing. You also want inventory levels to expand at the same speed as revenue growth, if not a little faster. (If it's too fast, product may be piling up on shelves; if it's too slow, the company may be losing sales.)

In this case, that's hard to measure, since Alcoa and Century Aluminum have seen their revenue slump over the past few years; Aluminum Corp. of China has experienced a bump in the last year. Inventory levels can sometimes rise when sales slump, as product piles up unsold. Many companies likely suffered that setback during our recent recession.

Learning how to look at inventory is just one way to help you understand a company better. The more you know, the better your chances of boosting your portfolio performance.

These stocks have sunk -- but they may still pay off well for investors.