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What Is a Safe Stock?

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Inflation continues to rock the markets with the latest CPI data from the Conference Board indicating that it has reached a 41-year high. There really are two sides to the story, one to do with food and energy, and the other to everything else.

Energy is unlikely to get much cheaper (oil was up 34.6% and gasoline up 48.7% on the year in May) because it suits OPEC+ to keep oil prices high. And the small planned increase this week is designed to increase revenue for the union and unlikely to move the needle for the rest of the world.

That means most goods will continue to get marked up simply because the freight bill continues to increase. So even if everything else cools down, which is not going to be easy in itself, we will still have a lot of inflation on our hands.

Food is the other segment seeing significant inflation (prices were up over 10% in May) for a myriad of reasons. The war in Ukraine came on top of other drivers of shortages in not only food grains but also vegetable oils. This set off a chain reaction, also driving up prices of meat and dairy.

With the pandemic becoming less of a factor, personal services are seeing increased demand (some of it pent up). And then of course there is the summer travel season, which is shaping up to be a rather strong one given all the pent-up demand. So the cost of hotel stay, motor vehicle maintenance and insurance, plane tickets and out-of-home entertainment are all on the rise.

A significant piece of the price escalation may be attributed to the persistent strength in home prices, driven by very low inventories and demographic-driven strength in demand. The Fed’s rate hikes have more of an impact on this market because rate hikes increase borrowing cost for the consumer, which increases the cost of acquiring a home, over and above the price escalation already seen across the market.

Which brings us to the question of borrowing cost. The reason rate hikes have such a far-reaching effect is their impact on the borrowing cost for both individuals and companies. When companies are faced with higher cost of doing business, they inevitably pass on the extra cost to consumers. And consumers respond by buying less or abstaining, depending on the essentiality of the product.

We would all want this to happen like clockwork, so demand shrinks only to the point that supply comes into balance, but not so much that businesses run into trouble. But unfortunately, it doesn’t always work out that way. So in this rising rate environment, companies carrying low corporate debt or operating an asset-light model, where too much debt isn’t required are probably safer bets.

And if you want to play even more safe, you could also check for a current ratio of 2 or more. This indicates that current assets are doubly capable of covering current liabilities. So these stocks may be considered better equipped to deal with short term contingencies if they should arise, given the current environment.

The other safety criteria are related to Zacks proprietary methodology that favors certain stocks with #1 (Strong Buy) or #2 (Buy) ratings. When paired with an attractive industry rank, i.e. the top 50% of Zacks-ranked industries, these stocks have a high probability of share price appreciation.

And finally, there is the question of valuation. Given what the markets are doing right now, it just wouldn’t pay to buy expensive. In order to ensure that one doesn’t make a mistake here, it is better to look beyond the mere cost of a stock in dollar terms, but more in terms of its price relative to current earnings, earnings growth or sales potential.

I’m using price-to-earnings (P/E) and price-to-earnings growth (PEG) measures here. Avnet, Cross Country Healthcare, Hudson Global and Tenaris look attractive picks based on these criteria.

Avnet (AVT - Free Report) , which is an electronic components distributor, has a debt/cap ratio of 17.8% (a percentage less than 60% is generally considered safe). So it has very low risk in terms of debt. Not only that – its current ratio is 2.02X.

The Zacks Rank #1 stock belongs to the Electronics - Parts Distribution industry (top 2% of Zacks-classified industries). Its P/E of 6.38X compares favorably with its recent history and the S&P 500 while its PEG of 0.17 indicates that investors are hugely discounting its earnings growth potential.

Cross Country Healthcare (CCRN - Free Report) , which provides healthcare and other staffing services, has a debt/cap ratio of 38.0% and a current ratio of 2.44X. The Zacks Rank #1 stock belongs to the Staffing Firms (top 31%).

As far as valuation is concerned, Cross Country’s P/E of 4.62X is close to its lowest point over the past year. Consequently, its PEG 0.67 also reflects significant undervaluation of its earnings growth potential.

Hudson Global (HSON - Free Report) is another provider of staffing services targeting mid-to-large-cap multinational companies and government agencies. Given its debt/cap ratio of 2.8%, the company has negligible debt. Its current ratio of 2.79X is also extremely encouraging.

This Zacks Rank #1 stock belongs to the Outsourcing industry (top 19%). On a P/E basis it trades close to its bottom over the past year. The PEG of 0.45 also signifies considerable undervaluation.

Another stock worth buying is Tenaris (TS - Free Report) . The steel producing company has a det/cap ratio of less than 1% and a current ratio of 2.97.

The Zacks Rank #1 stock belongs to the Steel - Pipe and Tube industry (top 7%). It is trading at a P/E of 8.18X (close to its lowest point over the past year) and PEG of 0.30.

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