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In the complex world of corporate finance, a company needs exogenous funds for smooth operations, meeting obligations and expanding business. Depending solely on retained earnings for business growth is next to impossible. The two financial resources often resorted to are debt and equity.
A comparative analysis of the cost of capital theory reveals that most companies prefer debt financing over equity, as debt is available at a lower cost compared to equity; especially in periods of low interest rates. This happens because when a company finances its operations with debt, it takes on fixed expenses in the form of interest payments for a fixed time period. Whereas, in case of equity financing, a shareholder not only becomes a partial owner of the company but develops a direct claim on the company’s future profits as well.
However debt financing has its own drawbacks. The problem arises when leverage, referred to as the amount of debt a company bears, becomes exorbitant. In particular, companies with large debt loads are more vulnerable during economic downturns and can even go bankrupt in the worst case scenario.
In fact, the greater the proportion of debt in a firm’s capital structure, the greater is its financial risk. That said, for the investor, the real challenge is determining whether the organization’s debt level is sustainable as a debt-free corporation is rare to find. Historically several leverage ratios have been developed to measure the amount of debt a company bears and the debt-to-equity ratio is one of the most common ratios.
What’s Debt-to-Equity?
Debt-to-Equity Ratio = Total Liabilities/Shareholders’ Equity
This metric is a liquidity ratio that reflects how much debt a company currently bears. A lower debt-to-equity ratio implies a comparatively less risky business and thereby instills investors’ confidence in a company’s financial stability.
In general, investors target companies exhibiting solid earnings growth projections. But in the uncertain world of investment, markets can trip anytime, particularly affecting companies with a higher degree of financial leverage. Therefore, blindly investing in stocks displaying solid earnings growth without considering their debt level is not a wise move.
Choosing the Winning Strategy
Considering the aforementioned discussion, it is imperative for an investor to choose stocks that have a low debt-to-equity ratio. To ensure the maximum possible return from this strategy, we have expanded our screening procedure to include some other criteria.
Here are the other parameters:
Debt/Equity less than X-Industry Median: Stocks that are less leveraged than their industry peers.
Current Price greater than or equal to 10: The stocks must be trading at a minimum of $10 or above.
Average 20-day Volume greater than or equal to 50000: A substantial trading volume ensures that the stock is easily tradable.
Percentage Change in EPS F(0)/F(-1) greater than X-Industry Median: Earnings growth adds to optimism, leading to a stock’s price appreciation.
Estimated One-Year EPS Growth F(1)/F(0) greater than 5: This shows earnings growth expectation.
Zacks Rank #1 (Strong Buy) or #2 (Buy): No matter whether market conditions are good or bad, stocks with a Zacks Rank #1 (Strong Buy) or 2 (Buy) have a proven history of success.
VGM Score of A or B: Our research shows that stocks with a VGM Score of ‘A’ or ‘B’ when combined with a Zacks Rank #1 or 2 offer the best upside potential
Excluding stocks that have a negative or a zero debt-to-equity ratio, here are five of the 19 stocks that made it through the screen.
American Woodmark Corp. (AMWD - Free Report) : This major manufacturer of quality kitchen and bath cabinetscarries a Zacks Rank #1. American Woodmark witnessed a 10.2% improvement in its current year consensus estimate in the last 30 days.
CONE Midstream Partners LP : This company develops natural gas gathering and other midstream energy assets and currently carries a Zacks Rank #1. Last quarter, CONE Midstream witnessed a positive earnings surprise of 8.33%.
NTT DOCOMO, Inc. : This Japanese company is a predominant mobile phone operator in the nation. DOCOMO witnessed a 7.2% improvement in its current year consensus estimate in the last 30 days.The company carries a Zacks Rank #1.You can see the complete list of today’s Zacks #1 Rank stocks here.
Universal Forest Products Inc. (UFPI - Free Report) : This manufacturer of wood, wood alternative and related products, which carries a Zacks Rank #1, witnessed a positive earnings surprise of 13.89% last quarter.
Stepan Company (SCL - Free Report) : This chemical solutions corporation holds a Zacks Rank #1 and witnessed a positive earnings surprise of 11.97% last quarter.
Get the rest of the stocks on the list and start putting this and other ideas to the test. It can all be done with the Research Wizard stock picking and back testing software.
The Research Wizard is a great place to begin. It's easy to use. Everything is in plain language. And it's very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open up the Research Wizard, plug your finds in, and see what gems come out.
Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.
Zacks Restaurant Recommendations: In addition to dining at these special places, you can feast on their stock shares. A Zacks Special Report spotlights 5 recent IPOs to watch plus 2 stocks that offer immediate promise in a booming sector. Download it free »
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5 Low Leverage Stocks to Boost Your Portfolio
In the complex world of corporate finance, a company needs exogenous funds for smooth operations, meeting obligations and expanding business. Depending solely on retained earnings for business growth is next to impossible. The two financial resources often resorted to are debt and equity.
A comparative analysis of the cost of capital theory reveals that most companies prefer debt financing over equity, as debt is available at a lower cost compared to equity; especially in periods of low interest rates. This happens because when a company finances its operations with debt, it takes on fixed expenses in the form of interest payments for a fixed time period. Whereas, in case of equity financing, a shareholder not only becomes a partial owner of the company but develops a direct claim on the company’s future profits as well.
However debt financing has its own drawbacks. The problem arises when leverage, referred to as the amount of debt a company bears, becomes exorbitant. In particular, companies with large debt loads are more vulnerable during economic downturns and can even go bankrupt in the worst case scenario.
In fact, the greater the proportion of debt in a firm’s capital structure, the greater is its financial risk. That said, for the investor, the real challenge is determining whether the organization’s debt level is sustainable as a debt-free corporation is rare to find. Historically several leverage ratios have been developed to measure the amount of debt a company bears and the debt-to-equity ratio is one of the most common ratios.
What’s Debt-to-Equity?
Debt-to-Equity Ratio = Total Liabilities/Shareholders’ Equity
This metric is a liquidity ratio that reflects how much debt a company currently bears. A lower debt-to-equity ratio implies a comparatively less risky business and thereby instills investors’ confidence in a company’s financial stability.
In general, investors target companies exhibiting solid earnings growth projections. But in the uncertain world of investment, markets can trip anytime, particularly affecting companies with a higher degree of financial leverage. Therefore, blindly investing in stocks displaying solid earnings growth without considering their debt level is not a wise move.
Choosing the Winning Strategy
Considering the aforementioned discussion, it is imperative for an investor to choose stocks that have a low debt-to-equity ratio. To ensure the maximum possible return from this strategy, we have expanded our screening procedure to include some other criteria.
Here are the other parameters:
Debt/Equity less than X-Industry Median: Stocks that are less leveraged than their industry peers.
Current Price greater than or equal to 10: The stocks must be trading at a minimum of $10 or above.
Average 20-day Volume greater than or equal to 50000: A substantial trading volume ensures that the stock is easily tradable.
Percentage Change in EPS F(0)/F(-1) greater than X-Industry Median: Earnings growth adds to optimism, leading to a stock’s price appreciation.
Estimated One-Year EPS Growth F(1)/F(0) greater than 5: This shows earnings growth expectation.
Zacks Rank #1 (Strong Buy) or #2 (Buy): No matter whether market conditions are good or bad, stocks with a Zacks Rank #1 (Strong Buy) or 2 (Buy) have a proven history of success.
VGM Score of A or B: Our research shows that stocks with a VGM Score of ‘A’ or ‘B’ when combined with a Zacks Rank #1 or 2 offer the best upside potential
Excluding stocks that have a negative or a zero debt-to-equity ratio, here are five of the 19 stocks that made it through the screen.
American Woodmark Corp. (AMWD - Free Report) : This major manufacturer of quality kitchen and bath cabinetscarries a Zacks Rank #1. American Woodmark witnessed a 10.2% improvement in its current year consensus estimate in the last 30 days.
CONE Midstream Partners LP : This company develops natural gas gathering and other midstream energy assets and currently carries a Zacks Rank #1. Last quarter, CONE Midstream witnessed a positive earnings surprise of 8.33%.
NTT DOCOMO, Inc. : This Japanese company is a predominant mobile phone operator in the nation. DOCOMO witnessed a 7.2% improvement in its current year consensus estimate in the last 30 days.The company carries a Zacks Rank #1.You can see the complete list of today’s Zacks #1 Rank stocks here.
Universal Forest Products Inc. (UFPI - Free Report) : This manufacturer of wood, wood alternative and related products, which carries a Zacks Rank #1, witnessed a positive earnings surprise of 13.89% last quarter.
Stepan Company (SCL - Free Report) : This chemical solutions corporation holds a Zacks Rank #1 and witnessed a positive earnings surprise of 11.97% last quarter.
Get the rest of the stocks on the list and start putting this and other ideas to the test. It can all be done with the Research Wizard stock picking and back testing software.
The Research Wizard is a great place to begin. It's easy to use. Everything is in plain language. And it's very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open up the Research Wizard, plug your finds in, and see what gems come out.
Click here to sign up for a free trial to the Research Wizard today.
Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.
Disclosure: Performance information for Zacks’ portfolios and strategies are available at: https://www.zacks.com/performance.
Zacks Restaurant Recommendations: In addition to dining at these special places, you can feast on their stock shares. A Zacks Special Report spotlights 5 recent IPOs to watch plus 2 stocks that offer immediate promise in a booming sector. Download it free »