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Current and quick

Ask the Fool

Published: May 14, 2024

Q. What are "current" and "quick" ratios? -- H.L., Lexington, Kentucky
A. They're measures of liquidity, reflecting how easily a company may be able to meet its short-term obligations.
The current ratio is the simplest: Just divide current assets by current liabilities (both figures can be found on the latest balance sheet). The quick ratio is actually less quick to calculate, as it subtracts less-liquid assets (such as inventory and prepaid expenses) from current assets before dividing by current liabilities. There's a third liquidity ratio, too -- the "cash ratio." It takes only the most liquid assets -- cash and marketable securities -- and divides them by current liabilities.
In general, each ratio should be 1 or more; ratios below that suggest the company may not be able to cover its immediate debts. However, an unusually high number may indicate a company not using its assets effectively. Current ratios will typically be higher than quick ratios, which will be higher than cash ratios. These figures can vary by industry, too, so it's best to compare a company's liquidity ratios with its peers -- or with itself over time, to spot trends.
Q. How can a company's earnings grow more slowly than its revenue? -- M.M., Savannah, Georgia
A. They don't necessarily grow at the same rate. For example, if a company's revenue (also known as "sales," and appearing at the top of its income statement) grows by 5% from one year to the next, but its costs increase by 30% (perhaps due to a tight supply of its raw materials), earnings growth will lag sales. But earnings that grow more quickly than revenue suggest increased efficiency and a growing profit margin.
Fool's School
Different Accounts, Different Investments
When investing money in various kinds of accounts, be mindful of what you park where -- because different assets get different tax treatments in various accounts.
For starters, consider buying investments that you have especially high hopes for, such as growth stocks, using a Roth IRA. That way, if your account does swell significantly, all that money may be withdrawn tax-free in retirement.
It's usually best to buy into great stocks with the intention of hanging on for a long time. But if you happen to be an active stock trader, consider doing much of your buying and selling in a tax-deferred or tax-free retirement account, such as an IRA. This avoids the short-term capital gains tax rate, which is the same as your ordinary income tax rate -- possibly 22%, 24%, 32% or more. Long-term capital gains, on assets you've held for more than a year, are taxed at a much more favorable rate, which for most of us is 15%.
Tax-deferred or tax-free accounts such as IRAs and 401(k)s are also good spots to park taxable bonds and bond funds, to delay or avoid paying taxes on that income. Otherwise, their interest payments to you will be taxed at your ordinary income tax rate. (Delayed taxes can be lower taxes, too, since many people drop into lower tax brackets when they retire.) These accounts are also good for actively managed mutual funds that generate a lot of short-term capital gains, and for real estate investment trusts (REITs).
Meanwhile, municipal bonds and municipal bond funds are fine to keep in regular, taxable accounts, since the interest they generate is typically tax-free. Such accounts can also be good places for index funds and for stocks you plan to hold for more than a year, as (at the moment) they'll eventually face that relatively low long-term capital gains rate.
Taxes can take a significant bite out of your gains, so it's worth aiming to minimize them.
My Dumbest Investment
The School of Hard Knocks
My most regrettable investing move happened back in 1999. My grandmother passed away and left me $25,000. I invested some of the money, around $600, in Apple. A short time later, the stock dropped sharply, and I sold all but one of my shares, thinking that the single share would keep Apple on my investment radar. That one share underwent four stock splits over the next 24 years, and became 112 shares -- worth a total of around $20,000! So, good for me for hanging on to one share in this portfolio, but it could have been $480,000 more if I had just kept those other shares. Oh, well, the school of hard knocks strikes again! -- K.F., online
The Fool responds: Many, if not all, investors have some great performers they regret selling too soon. Selling your Apple shares wasn't necessarily the wrong thing to do if you had little faith in the company's future at the time. Sharp drops can easily rattle investors, but when they happen, you should do some research to find out why.
Remember, too, that in 1999, many of Apple's amazing products had not yet been launched: The iPod debuted in 2001, the iPhone in 2007, the iPad in 2010, the Apple Watch in 2014 and AirPods in 2016.
(Do you have a smart or regrettable investment move to share with us? Email it to TMFShare@fool.com.)
Foolish Trivia
Name That Company
I trace my roots back to 1912, when two brothers launched the Alco Hydro-Aeroplane Company. That same year, another guy, advised by a Wright brother, built an airplane in a rented church and then launched a company. The companies that those two businesses grew into merged in 1995, forming me. Today, with a recent market value topping $100 billion, I'm a defense giant, with roughly three-quarters of my revenue coming from the United States government. I employ more than 120,000 people and make missile defense systems, fighter jets, Sikorsky helicopters, cybersecurity systems and much more. Who am I?
Last Week's Trivia Answer
I trace my roots back to 1990, when two men launched me with five stores in the Chicago area. I went public in 2007, and my stock has surged more than 1,700% since then. Today, based in Bolingbrook, Illinois, I'm America's largest beauty retailer; I offer cosmetics, fragrance, skin care products, hair care products and salon services. My market value recently topped $26 billion, and my 1,350-plus stores span all 50 states. I rake in almost $11 billion annually and employ more than 45,000 people, the vast majority of whom are women. I've won multiple "best employer" awards. Who am I? (Answer: Ulta Beauty)
The Motley Fool Take
Profits Are Brewing
Starbucks (Nasdaq: SBUX) is the largest coffee chain in the world and ended its fiscal 2024 first quarter with 38,587 stores. However, it promises lots of growth ahead: The company aims to increase its global store count to 55,000 locations by 2030, including 35,000 outside of North America. That's over 40% growth in its worldwide store count and a nearly 70% increase in locations outside of North America.
Besides its valuable brand, the company's sophisticated digital ordering capabilities are a key to its success; Starbucks has led the restaurant industry for years in this crucial area. And it recently boasted 34.3 million active rewards memberships in the U.S.
The future growth path for Starbucks is straightforward. A combination of new store growth, growth from existing stores and expanding profit margins may drive an increase of 15% to 20% in annualized earnings, based on management's targets. In the most recent quarter, Starbucks posted an adjusted year-over-year earnings increase of 20%.
Shares recently traded at a forward-looking price-to-earnings (P/E) ratio of 22, well below Starbucks' five-year average of 28. The stock pays a dividend, too, recently yielding about 2.5%, and it has increased that payout by an average of close to 10% annually over the past five years. Long-term investors should take a closer look. (The Motley Fool owns shares of and has recommended Starbucks.)