An accounting professor at the University of California at inventory, accounts receivable, and order backlogs. These are the strongest indicators and are more closely related to stock returns than reported earnings. In particular, investors should look at how companies’ inventories of finished goods track their sales. If inventories are rising faster than sales, it’s a bad signal. For similar reasons, it pays to watch accounts receivable .. If these are rising faster than sales, not only can this signal trouble with sales but may show vulnerability to customer defaults.
Required:
a. Which of the financial ratios best captures the indicators suggested by the Berkeley professor?
b. Explain how these ratios provide information about solvency and earning power and why they might be more closely related to stock prices than earnings.