How Well Do You Use Cash, Intuitive Surgical?

There are two parts to successful investing: Finding the winners and avoiding the losers.

But looking just for the former, especially if you focus mostly on revenue and earnings, can leave you exposed to the latter.

In order to fully benefit from your winners, you need to spot the stocks worth avoiding. After all, a 200% gain is completely wiped out by four other picks that drop 50% each. As for that winner, revenue and earnings are not the place to see trouble coming in time to do any good. You don't want to wait for an ugly earnings surprise that gives your stock a massive haircut before getting out.

That's why just about the first thing I read is the balance sheet. This is where the company's financial health is found, and where the warning signs of sickness often show up.

The cash conversion cycle (CCC) makes a particularly handy balance sheet tool. This metric shows how fast the company turns its cash into inventory, sells that inventory, and then collects the cash on those sales. It's measured in days, and generally, the lower it is, the better. (For details on how it's calculated, check the Foolsaurus investing wiki entry.) It's possible to have a negative CCC, as Dell showed to great effect for several years. Increasing CCC can suggest that a company's worth avoiding -- or abandoning.

This metric doesn't apply to every industry; banks are a notable exception. It's primarily for companies that interact with suppliers and customers, buying from one, selling to the other.

Here are three companies operating in the same industry that recently caught my eye:

Source: Capital IQ, a division of Standard & Poor's, and author calculations. TTM = trailing 12 months. All numbers are in days.

Toshiba has an advantage, in that medical devices are only one segment of the goods it sells. But for a pure-play medical-device maker, Intuitive Surgical isn't too bad. Coming out of the recession, it's nice to see the maker of robo-surgeons getting a handle on its cash cycle again, bringing it back down to the same levels seen five years ago. If management can continue to squeeze out efficiencies, it'll serve investors well.

Of course, the cash conversion cycle should not be the end of your research, and it's best to follow trends over time. Still, this metric can provide useful pointers for either getting into a stock, or staying away from it.

Go past the obsessive focus on quarterly earnings, and you'll be way ahead of the vast majority of the market's individual investors. By learning to calculate and use the cash conversion cycle, you'll more likely spot a deteriorating situation early enough to either avoid the company in the first place, or get out before it "surprises" with a bad earnings report.