Leverage refers to the use of exogenous funds by companies to run their operations smoothly and expand the same. Now, companies can obtain these exogenous funds either through equity financing or debt financing.
Statistically, it has been seen that debt financing is preferred over equity because of its easy and cheap availability.
The equity market is not a risk-free zone. Wall Street tumbled recently, with the major stock indices pulling back from record closing highs last week, in a broad sell-off driven by uncertainties surrounding the pace of the U.S. economic recovery. So, while choosing a stock one should be very careful.
In fact, even if companies mostly prefer debt financing, for an investor, a debt-ridden stock becomes a risky investment. This is because, too much of debt brings with it the burden of interest payment. So, to avoid considerable losses in your portfolio, one should always avoid companies that resort to exorbitant debt financing.
Therefore, the crux of safe investment lies in choosing a company that is not overburdened with debt as a debt-free stock is almost impossible to find.
For identifying such a safe bet, different ratios are being used by investors to measure the debt a company bears. One such ratio is debt-to-equity ratio.
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 second-quarter earnings season about to start, investors must be eyeing stocks that exhibited solid earnings growth in the past couple of 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 29 stocks that made it through the screen.
Nu Skin Enterprises ( NUS Quick Quote NUS - Free Report) : It develops and distributes a wide range of premium cosmetics, beauty, personal care and wellness products. The company delivered an earnings surprise of 18.76%, on average, in the trailing four quarters and carries a Zacks Rank #2 currently. Sonoco Products Company ( SON Quick Quote SON - Free Report) : It is a leading provider of consumer packaging, industrial products, protective packaging and packaging supply chain services. The company currently holds a Zacks Rank #2 and delivered an earnings surprise of 4.96% in the trailing four quarters, on average. Quanex Building Products Corporation ( NX Quick Quote NX - Free Report) : It designs and produces energy-efficient fenestration products in addition to kitchen and bath cabinet components. The company came up with a four-quarter earnings surprise of 444.09%, on average, and has a Zacks Rank of 2. You can see . the complete list of today’s Zacks #1 Rank stocks here Weingarten Realty Investors : It is focused on delivering solid returns to shareholders by actively developing, acquiring, and intensively managing properties in 21 states that span the southern portion of the United States from coast to coast.. Currently, the company carries a Zacks Rank of 2 and came up with a four-quarter earnings surprise of 3.61%, on average. Toronto Dominion Bank ( TD Quick Quote TD - Free Report) : It is a Canadian chartered bank and offers a wide range of business and consumer services. The company currently sports a Zacks Rank #1 and delivered a four-quarter earnings surprise of 21.60%, on average.
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. 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