The current ratio is a super-quick way to gauge a company's ability to pay off its short-term liabilities with its current assets. In general, investors look for companies with a current ratio above 1.0. But sometimes media hype, lofty company promises, or the idea of getting a bargain makes a stock below that number fatally attractive.
In this clip, The Motley Fool's Kristine Harjes and Todd Campbell explain why investors should look at the current ratio before investing, and give a cautionary example of what can happen if they don't.
A transcript follows the video. Listen to the full podcast by clicking here.
Kristine Harjes: So, one last quick example that we wanted to throw out here before we sign off for the day is MannKind (NASDAQ:56400P706) and their pretty horrible current ratio. Todd, do you want to dig into that?
Todd Campbell: Yeah. I think one of the reasons that it's helpful when we're diving into a balance sheet to show real-time examples of how this could have helped me as an investor. So, you look at it, and you say, "Well, how would the current ratio really have helped me either get into a stock or avoid a stock?" And in the case of MannKind, it would've helped you avoid it, because MannKind's current ratio has been below one all year long. So, despite all of the hope and optimism that perhaps there in inhalable insulin drug would reach critical mass, and help drive the company into the future, the fact that the current ratio was below one, they just didn't have enough assets that, if anything went wrong, they could cover their obligations. And that would have saved a lot of investors a lot of money, just by taking that extra second or two to look up the current ratio in the company and say, "You know what? I'm gonna let this stock prove itself to me before I go in and invest in it."
Harjes: Yeah. At the end of the day, it's easy to tell a story, especially when you're talking about healthcare, and you're talking about drugs that can save people's lives, or at the very least, vastly improve them. And while we would love to say every single innovative drug is going to change the world, this company's going to make billions and billions of dollars, sometimes that's just not the case. I think MannKind is a really good example here of a company that just doesn't have a financial situation that looks very promising.