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Buy These 5 Low Leverage Stocks to Shield Your Portfolio

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Sufficient capital is one of the major requirements for any company to run its operations smoothly. Now, many a times companies borrow funds to finance this capital either using debt or equity. And here comes the concept of leverage, which refers to the use of borrowed funds by companies in corporate finance.

While there remains an option for equity financing, most companies prefer debt financing. This is because when a company resorts to debt financing, it incurs 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 company’s partial owner but also gets entitled to a direct claim to its future profits.

Another perk of debt financing is that the interest on debt is tax deductible.

Yet, debt financing does possess some drawbacks. In particular, debt financing is not desirable if it fails to generate a higher rate of return compared to the interest rate. So, one should always avoid resorting to exorbitant debt financing, which might even lead to a corporation’s bankruptcy in the worst-case scenario.

Considering the current economic situation worldwide on account of the ongoing pandemic, most investors are skeptical about the stock market’s performance, at least over the near term. So, to avoid huge losses, a prudent investor will choose stocks that bear low leverage since a debt-free corporation is rare to find. Therefore, measuring the leverage level of a particular stock forms an integral part of the safe investment procedure.  

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.

Analyzing Debt/Equity

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 year 2020 almost at its end, investors might be eyeing stocks that have exhibited solid earnings growth year to date. 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.

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 (Strong Buy) or 2 (Buy) offer the best upside potential.

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 16 stocks that made it through the screen.

Sprouts Farmers Market (SFM - Free Report) : It is a supermarket chain, which offers a wide variety of food products. The company delivered an earnings surprise of 59.50%, on average, in the trailing four quarters and currently carries a Zacks Rank #2.

MarineMax (HZO - Free Report) : It is the United States’ largest recreational boat and yacht retailer. The company currently has a Zacks Rank #2 and delivered an earnings surprise of 263.62% in the trailing four quarters, on average.

Boise Cascade (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.

D.R. Horton (DHI - Free Report) : It is one of the leading national homebuilders, primarily engaged in the construction and sale of single-family houses both in the entry-level and move-up markets. Currently, the company sports a Zacks Rank #1 and came up with a four-quarter earnings surprise of 21.60%, on average.

Cooper Tire & Rubber Company (CTB - Free Report) : It manufactures, markets and sells tires of a wide range of vehicles, including truck and bus radials as well as motorcycles. It currently sports a Zacks Rank #1 and delivered a four-quarter earnings surprise of 106.84%, on average.

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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.