In the world of investment, leverage is the use of borrowed capital that companies use to invest in their business operations. Although funds can also be borrowed through stock issuance, debt is more popularly used as a means to raise capital.
This is because when a company resorts to debt financing, it takes on fixed expenses in the form of interest payments for a specific time period. However, 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.
Nevertheless, debt financing has its share of drawbacks. In particular, it becomes an issue when the amount of debt a company bears becomes exorbitant. A high degree of financial leverage means high interest payments, which affect the company's bottom line.
Now, a debt-free corporation is rare to find. Therefore, to safeguard one’s portfolio from notable losses, the real challenge for an investor is determining whether the organization’s debt level is sustainable.
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.
Debt-to-Equity Ratio = Total Liabilities/Shareholders’ Equity
This metric is a liquidity ratio that indicates the amount of financial risk a company bears. A company with a lower debt-to-equity ratio shows improved solvency for a company.
With the Q3 reporting cycle for this year having reached its last lap, investors must be eyeing stocks that exhibited solid earnings growth in the prior quarters. But if a stock bears a high debt-to-equity ratio, in times of economic downturns, its so-called booming earnings picture might turn into a nightmare.
The Winning Strategy
Considering the aforementioned factors, it is prudent to choose stocks with a low debt-to-equity ratio to ensure steady returns.
However, an investment strategy based solely on debt-to-equity ratio might not fetch the desired outcome. To choose stocks that have the potential to give you steady returns, we have expanded our screening criteria to include some other factors. 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. : Our research shows that stocks with a VGM Score of A or B when combined with a Zacks Rank #1 (Strong Buy) or 2 (Buy) offer the best upside potential. VGM Score of A or B Estimated One-Year EPS Growth F(1)/F(0) greater than 5: This shows earnings growth expectation Zacks Rank #1 or 2: Irrespective of market conditions, stocks with a Zacks Rank #1 (Strong Buy) or 2 (Buy) have a proven history of success.
Excluding stocks that have a negative or a zero debt-to-equity ratio, here are five of the nine stocks that made it through the screen.
Titan Machinery ( TITN Quick Quote TITN - Free Report) : It owns and operates a network of over 70 full-service agriculture and construction equipment stores across the United States and six countries in Europe. At its stores, the company sells new and used construction and farm equipment, as well as offer construction rental equipment. The company delivered an earnings surprise of 349.16%, on average, in the trailing four quarters and currently sports a Zacks Rank #1. Copper Tire Rubber Company ( CTB Quick Quote CTB - Free Report) : It manufactures, markets and sells tires of a wide range of vehicles, including truck and bus radials, as well as motorcycles. The company currently has a Zacks Rank #1 and delivered an earnings surprise of 106.84% in the trailing four quarters, on average. Boise Cascade ( BCC Quick Quote BCC - Free Report) : It operates as a wood products manufacturer and building materials distributor. The company came up with a four-quarter earnings surprise of 48.19%, on average, and carries a Zacks Rank #2. You can see . the complete list of today’s Zacks #1 Rank stocks here CBIZ ( CBZ Quick Quote CBZ - Free Report) : It provides professional business services that help clients better manage their finances and employees. Currently, the company carries a Zacks Rank #2 and came up with a four-quarter earnings surprise of 33.93%, on average. MarineMax ( HZO Quick Quote HZO - Free Report) : It is the United States’ largest recreational boat and yacht retailer. It currently sports a Zacks Rank #1 and delivered a four-quarter earnings surprise of 263.62%, on average.
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