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So when you're looking at like a margin of safety, when you're investing in stocks, particularly like

a value stock that might be selling at a reduced price because something is going on with the stock,

you want to make sure that they can pay their bills just like you or me.

What's important that we're able to pay our bills and we have actually measures that can we can use

this to evaluate different companies and their ability to pay their current bills.

Think of it as the what we call the current ratio and quick ratio, and these are emergency safety tools

we're going to learn about in this lesson.

And that's the big question can a company cover their short term debts?

Or we might not commonly known as bills, but in the finance parlance, we consider them short term

debts.

Debts are usually less than a year old or are coming due within a year versus a long term debt, something

that's going to be, you know, do to pay a year or more out.

So we're looking at short term some of those coming due right away or within a year.

So what happens if a company can't cover their debts?

Bills are coming due, they've got to pay them.

What?

What are they do?

What are some things they can do?

And they're not good things, particularly for our stock price, so they can reduce their expenses.

There's different ways to do that.

One is to layoff people that's always ugly and nasty, especially if you're one of the people getting

laid off so they can reduce their expenses.

They can also reduce their expenses by spending less on really key in important areas, such as training

for their team members, marketing, research and development.

All these things can have longer term consequences as far as having the company be successful going

forward, but they may need to reduce their expenses in the short term to meet these obligations.

Another thing they can do is sell off assets, right?

They can sell off plants or factories or entire divisions.

They can sell off, you know, they can do all sorts of things to sell off different assets, equipment,

you know, all sorts of things they can do.

Again, thinking long term, these might have been assets that could have been used in the future,

but now we need to sell them to cover our short term obligations, or we could take on more debt.

See that happen right where where companies need to service their debt or pay their debt.

And so they take on more debt with a longer term rate as as term being when it comes do.

So they use the longer term debt to cover the short term debt.

And we know of a company never really turns it around and never really gets that under control.

It's almost like a Ponzi scheme where at some point, you know, all this debt is going to come due

and they're not going will pay it, and that becomes a problem.

Or they could cut or eliminate their dividend.

Remember, dividends are payments are getting paid to shareholders, people like you and I who own stock

as part of our compensation for investing in a company.

But a company can decide what they want to pay in a dividend.

They don't have to pay a dividend so they could reduce that payment amount or they could eliminate that

dividend altogether.

That way, cash is not going out of the company to pay us.

They can use that cash in the company to pay their short term debt might be good for the company, but

not good for us as far as stockholders.

So when they do these things, what can happen?

You know what can happen if they can't cover their debt and they do some of these things?

What are some possible results in significant?

What can happen is the stock price can go down.

Sometimes it can go way down when we start doing these things, particularly if they're cutting a dividend,

you know where they you know where they're taking that money away from shareholders.

Sometimes you can have a little opposite thing.

This is the unfortunate thing where you see companies announce layoffs and their stock price goes up

because they're cutting off their expenses.

But the shareholders like the idea that they're not getting their dividend cut or they're doing things

to try to help improve the company.

From a shareholder owner standpoint, that doesn't help.

Of course, the poor people have been let laid off, but that's the unfortunate thing where sometimes

layoffs can be a good thing for a stock price, but usually certainly for the long term.

The stock price can go down if they have a struggle covering their debts and if they never recover,

they're never able to cover their debts if they take on more debt to try to cover the short term debt.

You know, then they can end up things like filing for bankruptcy or maybe selling off even more assets

or things that really reduced rates because people know that the company is in trouble and can negotiate

better things.

So being able to cover your short term debts is real.

Important is important for us to be able to measure that and the measures that we would use for that

are called the current and quick ratios.

And I'm going to show you how they kind of work here, but that's really the current and quick ratios

measure a company's ability to service or in effect, pay their short term debt.

So it's looking at short term debts and their ability to pay that they're easy to calculate.

I'm going to show you that.

So we understand that the under lying calculations and what the difference is between them, but they're

easy to look up and haven't calculated for you, and I'll show you that as well where you can look these

things up for company so you don't have to do the manual calculation so you don't want to.

And again, the key is they're looking at short term, not long term debt, things like more like debt

to equity ratio, things of that.

Consider more long term debt.

And these ratios, we're looking at short term ability to pay their current debts and be solvent that

way.

So let's start with the current ratio.

Very common thing that's used in investing is the current ratio.

Sometimes it's known as the.

Working capital calculations are working, capital ratio is a very simple calculation, you're basically

taking your current assets divided by your current liabilities, so current assets with big things like

cash accounts receivable.

That's money that people over the company, they bought something on credit, for example.

Now the owes all the company money so that accounts receivable assets are things like inventory that

you can sell off and other assets are expected to turn into cash in less than one year.

So that's the key.

Current assets are things, and current liabilities are all things that are within what's going to happen

within one year.

And these are things that you can return the cash and then you can use those cash, use that cash to

pay your short term debt.

So if current assets and then you'd rather buy current liabilities, which are things like accounts

payable, that's debt or bills that we owe.

For example, they're coming to accounts payable.

We have a wages, so we are we are employees money and that's coming up as far as liabilities.

So we have wages, taxes that we got to pay.

We got to pay taxes and the current portion of long term debt.

You know, maybe you have something that, you know, long term debt that's like a 10 year note.

So you've got to pay off in installments every year.

So current ratio would look at what the current year your one tenth of that basically would be considered

as a current liability.

The rest of the debt is further out from year two through 10.

So what's going to happen one term in the next year in terms of current liabilities and the killers?

When you calculate this where we look it up, the higher the number, the better.

If I have more assets, particularly these liquid assets like cash and accountancy or immaterial, that

that we can use thing to cover our debt up.

More of those are better than having more debt, so we want a number above 1.0, ideally the show that

we can least cover our debts one on a one to one ratio.

But if we're at 2.0 or a higher number, that's even better.

And it's also best to compare it against the peers, as in other companies in that in that sector of

space, you know, somebody who in defense contracts may be treated differently than apparel company

versus a technology company versus, let's say, like a consumer goods company.

So all these things that you can still compare them against different sectors, but it's a little bit

fair to compare it with in the sector.

So that's the current racial and current assets versus current liabilities.

Now, for some folks, they want to look at what's called a quick ratio, sometimes known as the acid

test ratio.

And the idea of the quick ratio is you're looking at more current, you know, even more liquid or more

current types of things.

You can see the formula here where you've got the quick ratio and you're looking a cash or cash equivalents

of things that can be really turned on cash real quickly.

Marketable securities, that's like stocks and things that they own or bonds or things that they own,

that they can get money in from these other companies or marketable securities in accounts receivable.

Again, money that's owed to the company that's coming in divided by that similar or that same current

liabilities.

All this is happening within one year again, and the keys to the quick ratio is that the more conservative

number than the current ratio, so quick ratio will always be less than a a lower number than a current

ratio.

You both want them to be above one, ideally, but certainly the higher number, the better.

But your quick ratio always be less than your current ratio.

And the reason for that is it's looking at less assets and looking at assets that are more liquid means

that can be easily turned into cash faster and real easily without having to maybe take some price reductions

or things on something.

So that's why something like inventory they exclude typically will exclude inventory because some inventory,

especially finished goods, can be turned easily into cash, possibly depending how your sales are going,

and some might be a little bit more stagnant or not.

Turn over their inventory, turn over as quickly.

Think about like if you were a rubber manufacturer, right?

You harvest and you make things out of rubber.

And one of your big products is rubber tires that you would you sell to automobile manufacturers?

But let's say the automobile manufacturing industry is hit hard and they're selling cars, so they're

not going to be buying your tires.

And so you're not going to be able to generate that.

Those that rubber into cash or that inventory, especially raw goods like rubber into into cash quickly

or as quickly as something like a cash or marketable security or accounts receivable.

So it's a little bit tougher.

No more conservative.

No.

And again, the higher the number, the better and best to compare against your peers when you look

at both current and quick ratio.

So how do we look these?

So knowing how to calculate the underlying basis of them, you know they're easy to look up to.

There's different tools you can use, but I'm going to show you one here.

That's a real easy tool to look at and for screening stocks and for finding finding these numbers.

And this is Finn Wills he may have used to before.

It's called Finn with it's a Finn WSJ.com.

If I values XCOM, you can find it and you when you get to their home page, you want to see where that

first circle is.

There you click where it's a screener up in the upper left there you'll find all these different screener

things and then you want to go down to this little bar.

Bosworth says like overview, valuation of financial ownership at all this little line below you need

just click the part worth this financial and then it comes up with this what I'll show, then change

above that and you can kind of then sort it out by different things.

You want to screen your stocks for it.

So let's say I'm interested in consumer stocks, you know, and you know, things like food people would

eat, for example.

So I could say, and this is where it's highlighted in yellow, there are.

These are the choices I made.

I left everything else the same.

Let's say I'm looking for things on the New York Stock Exchange, just the New York Stock Exchange versus

the Nasdaq.

They can leave that for all stocks, but I'm going to say New York Stock Exchange, and I'm looking

at really large companies.

So I'm just for curiosity.

I'm looking at large companies and you can see in terms of bill there where I'm looking at consumer

defensive stocks.

Consumer defense, it would be like stocks that are going to sell because no matter what's happening

in the market, right, so people are going to buy food, people are going to buy household cleaning

products or things like toothpaste were worth something like a more consumer cyclical stock or discretionary

stock like, let's say, shoes.

You don't have to buy shoes or certainly a name brand shoes like a Nike, but you probably do want to

buy some food, for example.

So that's just how they organized these different sectors or industries.

So I selected that.

And then you'll see in the middle part there, I've got this big red square there where it says, you

know, Kerr and quick are that's your current ratio and your quick ratio so you can stand the stocks.

They would list them on the left.

A whole long list of stocks, and you can kind of look at their current ratios.

And when you do it, you'll see that I pulled a three of them out here just so we could kind of get

a feel and look at them.

And some of the companies are well known.

So I have a Campbell's soup here, so you might know them for making soup served.

We're famous for so so during recessions and things, people buy lots of soup and you can see that they

run a current ratio below 1.0.

So that's a little could be a little scary, but again, they're a little bit more if they can kind

of count on that money coming in regularly so they can kind of manage around that.

So Kurt ratio point eight and a quick ratio a point five getting pretty low there.

But that's something to consider, like if you're comparing Campbell's soup versus other stocks like,

let's say, Hershey chocolate, right?

So Hershey Chocolate makes chocolate bars and good chocolate products has a current ratio of one point

four.

So above that 1.0 we're looking for, that's good and a quick ratio.

The more acid test or the more challenging or more consumer numbers at a one point.

Also, in terms of their ability to meet their short term obligations, they're really good shape.

And then another one to compare would be like General Mills.

They make cereal like Cheerios cereal, for example.

Believe they still own you'll play yogurt or if they sold it off, I'm not sure, but they but they

own a lot of different types of food and packaged food type products.

You can see they're at a current ratio point seventeen point five.

So if you're looking just at that number, you could say in comparing these three companies, we were

seeing at least three you might be interested in investing, you'd say, well, at least as far as meeting

its short term obligations, a margin of safety.

Hershey chocolate would be the better bet in comparison to the other two companies.

Again, also time when comparing within its industry, I happen to look up Nike, for example, just

for fun, and Nike runs a current ratio of two point five.

Oh, and a quick ratio of one point eight.

You think about that, they need more of a margin of safety for a consumer discretionary stock.

So if things go bad in the economy or Nike struggles for something, maybe they had a big shoe recall

or some scandal, which they've had in the past, of course, too.

As far as the manufacturer issues the they need to be able to meet their short term debt so they carry

a little bit more cash and things on hand to meet those obligations and thus their current ratio and

a quick ratio, or two point five and one point you don't eat all versus these lower numbers for these

discretionary or, excuse me, these defensive consumer stocks things that people are probably going

to buy.

So again, current ratio in quick ratio.

Great way to get a quick look at a company and its ability to meet its current debt.

It's a great margin of safety tool because if the stock prices down, but I think a good current ratios

and quick ratios, you know, that shows that they're able least meet their obligations and then hopefully

have a rebound.

But you want to look at a lot of other factors too, of course.

But this is two ratios that can really help you.

So is understanding their short term obligations and ability to meet them.