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Bet on These 5 Low Leverage Stocks to Avoid Debt-Related Risk

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Leverage refers to the common practice of using exogenous funds by corporations to run their operations smoothly and expand the same. Such use of funds is also termed as debt financing.  Although there is an option for equity financing, historically, debt financing has been preferred over equity because of its easy and cheap availability.

On the other hand, in case of equity financing, a shareholder not only becomes a company’s partial owner but also gets entitled to a direct claim on its future profits.  

However, debt financing can prove to be harmful if not carefully managed. 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.

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.

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 this year’s first-quarter reporting cycle underway, investors might be eyeing stocks that have exhibited solid earnings growth in the recent 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.

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 26 stocks that made it through the screen.

Ternium S.A. (TX - Free Report) : It  is the leading producer of flat and long-steel products of Latin America and consolidates the operations of the steel companies. The company has an earnings surprise of 197.78%, on average, in the trailing four quarters and sports a Zacks Rank #1 currently.

ASML Holding N.V. (ASML - Free Report) : It is a manufacturer of advanced technology systems for the semiconductor industry.. The company currently carries a Zacks Rank #2 and delivered an earnings surprise of 13.06% in the trailing four quarters, on average.

Nucor Corporation (NUE - Free Report) : It is a leading producer of structural steel, steel bars, steel joists, steel deck and cold finished bars in the United States. The company came up with a four-quarter earnings surprise of 46.72%, on average, and sports a Zacks Rank of 1. You can see the complete list of today’s Zacks #1 Rank stocks here.

Skyline Corporation (SKY - Free Report) : It designs, produces and distributes manufactured housing and recreational vehicles.. Currently, the company carries a Zacks Rank of 2 and came up with a four-quarter earnings surprise of 61.99%, on average.

Deckers Outdoor Corporation (DECK - Free Report) : It is a leading designer, producer, and brand manager of innovative, niche footwear and accessories developed for outdoor sports, and other lifestyle-related activities. It currently holds a Zacks Rank #2 and delivered a four-quarter earnings surprise of 485.05%, 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.



 

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