doing a CFA mock I have found a question regarding the inventory/sales ratio and the answer was: The Czech Republic shows a marked decline in the inventory/sales ratio. When the inventory/sales ratio decreases over time, the economy is likely to be strong in the next few quarters as businesses try to rebuild inventory.
In the schweser notes (secret sauce) they say: The measure (inventory/sales) increases when business gain confidence in the future of the economy and add to their inventories in anticipation of increasing demand for their output.
To me it sounds like they are the same statement, just the Czech Republic example is earlier on in the timeline.
CFAI: low ratio > “likely to be strong in next few quarters” (sounds like they are about to rebuild) Schweser: “ratio increases when companies add to their inventories” (sounds like they have already rebuilt)
It is not contradictory. High aggregate Inventory/ Sales ratio means that the managers are overconfident and is one of early indicators that economy is going to recession while this ratio was peaked. That said, decline in this ratio meaning the strengthening of overall economy.
What if companies decide not to replenish inventories with stable demand - that would bring a decline in the ratio but would not necessarily mean a strengthening in the economy?
Inventory/sales ratio can show both, but the analyst needs to check why the ratio is increasing. If it’s because sales are decreasing, and inventory is accumulating because of decrease of sales, then it’s a sign of negative growth ahead. If it’s because inventory levels are increasing due to optimism of producers (who stock up because they believe sales will increase even more in the future), then it’s a sign of a growth phase ahead.
It is an aggregate ratio. It’s hard to believe that all companies will proceed in same direction. Same is with writing off inventories. But, upon same occasions might be a false signal. For example a jump in technology change with many writing off of obsolete stocks or some kind of national disaster as earthquake which could cause damages on inventories.