“Growth based on debt is unsustainable, artificial” – Jose Manuel Barroso
Indeed, with macroeconomic and sociopolitical uncertainties engulfing the world of investment, risk-averse investors are in favor of companies bearing a low amount of debt. Of course, debt financing forms a crucial strategy of corporate financing, but too much debt bears the risk of dragging a company into financial distress.
This is because leverage holds the potential to move a company’s earnings both up and down.
Historically, varied leverage ratios have been constructed to measure the extent of leverage that a company bears. One such renowned measure is debt-to-equity ratio.
Debt-to-Equity Ratio = Total Liabilities/Shareholders’ Equity
A lower debt-to-equity ratio implies a more financially stable business, thereby making it a more worthy investment opportunity. With the first-quarter earnings season almost over, investors must be eager to spend money on stocks exhibiting a surge in earnings. But if the stocks bear a high debt-to-equity ratio, in times of economic downturns their so-called booming earnings picture might turn into a nightmare.
So, instead of targeting stocks showing an earnings boom, which might be short-lived, it would be wise for investors to go after those which are financially more secure and immune to financial bankruptcy.
Picking the Right Strategy
Choosing stocks based solely on one financial metric might not fetch the desired outcome.
To ensure maximum possible return from this strategy, we have expanded our screening procedure to include some other criteria. Particularly, we added a low P/E ratio and favorable Value Style Score to the screen to shortlist cheap stock.
Here is the final screen:
Debt/Equity less than X-Industry Median: Thestocks are less leveragedthan their industry peers.
Current Price greater than or equal to 5: The stocks must be trading at a minimum of $5 or above.
Average 20-day Volume greater than or equal to 50000: Asubstantial trading volume ensures that the stock is easily tradable.
Percentage Change in EPS F(0)/F(-1) greater than X-Industry Median: Earnings growth add to optimism, leading to a stock’s price appreciation.
Estimated One-Year EPS Growth F(1)/F(0) greater than 5: This shows earnings growth expectation.
Zacks Rank #1 (Strong Buy) or #2 (Buy): No matterwhether market conditions are good or bad, stocks with a Zacks Rank #1 (Strong Buy) or 2 (Buy) have a proven history of success.
Value Score of A or B:Our research shows that stocks with a Value Score of ‘A’ or ‘B’ when combined with a Zacks Rank #1 or 2 offer the best upside potential.
P/E (using F1 estimates) less than or equal to 15: This selects undervalued stocks.
Although 20 stocks passed the screen, we have eliminated those that had a negative or a zero debt-to-equity ratio.
Here are five stocks from the final 12 that have a favorable debt-to-equity ratio:
Get the rest of the stocks on the list and start putting this and other ideas to the test. It can all be done with the Research Wizard stock picking and back testing software.
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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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