Back to top

Image: Bigstock

4 Stocks That Boast Impressive Interest Coverage Ratio

Read MoreHide Full Article

Addressing shooting commodity prices is of top priority for the Federal Reserve, and it is treading the path of a rate hike to tame the same. We note that the consumer price index rose 1% month on month in May, following an increase of 0.3% in April. On a year-over-year basis, the metric rose 8.6% — the fastest pace since December 1981. This jump was led by higher gasoline and food grain prices, primarily due to the conflict between Russia and Ukraine.

At present, investors should gauge the changing market dynamics and accordingly chalk out a sturdy investment strategy. We often judge a company on the basis of its sales and earnings. These, however, may not be enough. Sometimes, a stock gets a boost if these numbers climb year over year or surpass estimates in a particular quarter, thus offering a great opportunity for an investor with a shorter horizon to cash in on. But if you seek long-term returns, investments backed only by sales and earnings numbers may not yield the desired results.

A critical analysis of a company’s financial background is a prerequisite for an informed investment decision. Here, coverage ratios that determine whether a company is sound enough to meet its financial obligations play a crucial role. The higher the ratio, the better. The focus of this article is on “Interest Coverage,” which is one such ratio.

Interest Coverage Ratio = Earnings before Interest & Taxes (EBIT) divided by Interest Expense.

Why Interest Coverage Ratio?

Interest Coverage Ratio is used to determine how effectively a company can pay the interest charges on its debt.

Debt, which is crucial for most of the companies to finance operations, comes at a cost called interest. Interest expense has a direct bearing on the profitability of a company and its creditworthiness depends on how effectively it meets interest obligations. Therefore, Interest Coverage Ratio is one of the important criteria to factor in before making any investment decision.
Interest coverage ratio suggests the number of times the interest could be paid from earnings and gauges the margin of safety a firm carries for paying interest.

An interest coverage ratio lower than 1.0 implies that the company is unable to fulfill its interest obligations and could default on repaying debt. A company that is capable of generating earnings well above its interest expense can withstand financial hardships. Definitely, one should also track the company’s past performance to determine whether the interest coverage ratio has improved or worsened over a period of time.

The Winning Strategy

Apart from having an Interest Coverage Ratio that is more than the industry average, adding a favorable Zacks Rank and a VGM Score of A or B to your search criteria should lead to better results.

Interest Coverage Ratio greater than X-Industry Median

Price greater than or equal to 5: The stocks must all be trading at a minimum of $5 or higher.

5-Year Historical EPS Growth (%) greater than X-Industry Median: Stocks that have a strong EPS growth history.

Projected EPS Growth (%) greater than X-Industry Median: This is the projected EPS growth over the next three to five years. This shows that the stock has near-term earnings growth potential.

Average 20-Day Volume greater than 100,000: A substantial trading volume ensures that the stock is easily tradable.

Zacks Rank less than or equal to 2: Zacks Rank #1 (Strong Buy) or 2 (Buy) stocks are known to outperform irrespective of the market environment.

VGM Score of less than or equal to B: Our research shows that stocks with a VGM Score of A or B when combined with a Zacks Rank #1 or 2 offer the best upside potential.

Here are four of the 11 stocks that qualified the screening:

Dillard's, Inc. (DDS - Free Report) which operates retail department stores, has a Zacks Rank #1 and a VGM Score of A. Its expected EPS growth rate for three-five years is 14.6%. You can see the complete list of today’s Zacks #1 Rank stocks here.

The Zacks Consensus Estimate for Dillard's current financial year sales suggests growth of 6.1% from the year-ago period. DDS has a trailing four-quarter earnings surprise of 224.1%, on average. The stock has zoomed 42.9% in the past year.

Avis Budget Group, Inc. (CAR - Free Report) , a leading global provider of mobility solutions, which has a Zacks Rank #1 and a VGM Score of A. Its expected EPS growth rate for three-five years is 19.4%.

The Zacks Consensus Estimate for Avis Budget Group’s current financial year sales and EPS suggests growth of 23.1% and 74.7%, respectively, from the year-ago period. Avis Budget has a trailing four-quarter earnings surprise of 102.1%, on average. The stock has rallied 105.8% in the past year.

Wyndham Hotels & Resorts, Inc. (WH - Free Report) , the world's largest hotel franchising company by the number of properties, has a Zacks Rank #2 and a VGM Score of A. The expected EPS growth rate for three-five years is 13.4%.

The Zacks Consensus Estimate for Wyndham Hotels & Resorts’ current financial year EPS suggests growth of 13% from the year-ago period. Wyndham Hotels & Resorts has a trailing four-quarter earnings surprise of 36.1%, on average. The stock has declined 5% in the past year.

American International Group, Inc. (AIG - Free Report) , which offers insurance products for commercial, institutional, and individual customers, has a Zacks Rank #2 and a VGM Score of B. The expected EPS growth rate for three-five years is 10%.

The Zacks Consensus Estimate for American International Group’s current financial year sales and EPS suggests growth of 0.6% and 1.2%, respectively, from the year-ago period. AIG has a trailing four-quarter earnings surprise of 18.9%, on average. The stock has advanced 9.6% in the past year.

You can get the rest of the stocks on this list by signing up now for your 2-week free trial to the Research Wizard and start using this screen in your own trading. Further, you can also create your own strategies and backtest them first before taking the investment plunge.

The Research Wizard is a great place to begin. It's easy to use. Everything is in plain language. And it's very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open up the Research Wizard, plug your finds in, and see what gems come out.

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.