Leverage, otherwise termed as debt financing, is the use of exogenous funds by corporations to run their operations smoothly and expand the same. Although there is an option for equity financing, historically, debt financing has been preferred over equity because of its easy and cheap availability.
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. Evidently, over the past few days, we have witnessed fluctuations in the stock market over concerns about heightened stock market valuations, raging coronavirus cases and any potential disruption to vaccine rollouts.
So, to avoid huge losses, a prudent investor should always go for 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.
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.
As we have started 2021, investors might be eyeing stocks that have exhibited solid earnings growth in 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 20 stocks that made it through the screen.
DICKS Sporting Goods ( DKS Quick Quote DKS - Free Report) : It operates as a major omni-channel sporting goods retailer, offering athletic shoes, apparel, accessories and a broad selection of outdoor and athletic equipment. The company delivered an earnings surprise of 34.73%, on average, in the trailing four quarters and currently carries a Zacks Rank #2. Plexus Corp. ( PLXS Quick Quote PLXS - Free Report) : It offers electronic contract manufacturing services to original equipment manufacturers (OEMs) in a wide range of industries. The company currently has a Zacks Rank #2 and delivered an earnings surprise of 29.50% in the trailing four quarters, on average. ASML Holding ( ASML Quick Quote ASML - Free Report) : It is a manufacturer of advanced technology systems for the semiconductor industry. The company came up with a four-quarter earnings surprise of 13.06%, 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 Quick Quote 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 holds a Zacks Rank #2 and came up with a four-quarter earnings surprise of 25.80%, on average. Lennar Corporation ( LEN Quick Quote LEN - Free Report) : It is engaged in homebuilding and financial services in the United States. It currently sports a Zacks Rank #1 and delivered a four-quarter earnings surprise of 32.05%, on average.
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Disclosure: Performance information for Zacks’ portfolios and strategies are available at: . https://www.zacks.com/performance