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A layman will fool himself if he decides to pick a stock only on the basis of shooting numbers on the real-time stock screen. A critical analysis of the company’s financial background is essential for a better investment decision.

Often investors evaluate a company’s performance by simply looking at its sales and earnings, which sometimes do not reveal the real picture. To be more precise, they do not tell whether a company’s fundamentals are sound enough to meet its financial obligations. Here the role of coverage ratios comes in to play — the higher these are the more efficient an enterprise will be in meeting its financial obligations.

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 important for financing operations of the majority of companies, comes at a cost called interest. Interest expense has a direct bearing on the profitability of a company. And the company’s creditworthiness depends on how effectively it meets its interest obligations. Therefore, Interest Coverage Ratio is one of the important criteria to factor in before making any investment decision.

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

The Interest Coverage Ratio suggests how many times the interest could be paid from earnings and also gauges the margin of safety a firm has for paying interest.

An interest coverage ratio lower than one implies that the company is incapable of fulfilling 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. It 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 seven of the 21 stocks that qualified the screening:

Packaging Corporation of America (PKG - Free Report) , a manufacturer and seller of containerboard and corrugated packaging products, has a Zacks Rank #1 and a VGM score of “B”. The expected EPS growth rate for 3–5 years currently stands at 11.5%.

Francesca's Holdings Corporation (FRAN - Free Report) , which operates a chain of retail boutiques, has a VGM score of “A” with an expected EPS growth rate for 3–5 years currently pegged at 13.8%. The stock flaunts a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.

Papa John's International Inc. (PZZA - Free Report) , which operates and franchises pizza delivery and carryout restaurants under the Papa Johns trademark, has a Zacks Rank #2 and a VGM score of “B”. The expected EPS growth rate for 3–5 years currently stands at 15.5%.

Neenah Paper, Inc. (NP - Free Report) , the producer and seller of technical products and fine paper and packaging products globally, has a Zacks Rank #2 and a VGM score of “B”. The expected EPS growth rate for 3–5 years is currently 10%.

EnerSys (ENS - Free Report) , the manufacturer, marketer, and distributor of industrial batteries, has a VGM score of “A” with an expected EPS growth rate of 13% for 3–5 years. The stock currently carries a Zacks Rank #2.

Boise Cascade Company (BCC - Free Report) , which manufactures wood products and distributes building materials, has a Zacks Rank #2 and a VGM score of “B”. The expected EPS growth rate for 3–5 years is pegged at 12.1%.

Colliers International Group Inc. (CIGI - Free Report) , the provider of commercial real estate services, has a Zacks Rank #2 and a VGM score of “A”. For the next 3–5 years, the expected EPS growth rate is pegged at 15%.

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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.

Zacks Restaurant Recommendations: In addition to dining at these special places, you can feast on their stock shares. A Zacks Special Report spotlights 5 recent IPOs to watch plus 2 stocks that offer immediate promise in a booming sector. Download it free »

Zacks Restaurant Recommendations: In addition to dining at these special places, you can feast on their stock shares. A Zacks Special Report spotlights 5 recent IPOs to watch plus 2 stocks that offer immediate promise in a booming sector. Download it free »