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The victory of Donald Trump resulted in a surprise rally in domestic securities last week, raising hopes for more such upswings in the future. Moreover, the nation’s comparatively lower unemployment rate of 4.9% at present and a spike in the U.S. Treasury bond yields following the election results are indicative of strengthening economic conditions in the nation.

However, considering the fact that uncertainty can hit the global equity market anytime, without any prior notice, it is better to be prepared than repent later. Since debt ridden companies are more vulnerable at times of volatility, it is better to avoid those for achieving optimal returns.

Of course, entirely avoiding companies with debt loads is virtually impossible as debt financing is an inherent feature of corporate financing. Still eliminating those bearing exorbitant debt loads might be a wise idea, since the more the company is leveraged the more it is prone to get hit at times of a financial crunch.

So estimating the amount of debt a company currently bears has become a crucial part of an equity investment decision. For that purpose, leverage ratios are used by analysts to ensure that no investor chooses corporations with a high debt burden.

Debt-to-equity ratio is one such measure, perhaps the most popular one,  widely used to evaluate a company’s credit worthiness, for potential equity investments. 

What’s Debt-to-Equity?

Debt-to-Equity Ratio = Total Liabilities/Shareholders’ Equity

This metric is a liquidity ratio that reflects how much debt a company currently bears. A lower debt-to-equity ratio implies a comparatively less risky business and thereby instills investors’ confidence in a company’s financial stability.

With the Q3 reporting cycle almost over for this year, it is quite evident that the growth picture has improved compared to what we saw in the trailing quarters. Naturally, investors will now target stocks exhibiting solid earnings growth.

But choosing stocks that boast earnings growth only might not be a wise investment strategy. A higher degree of leverage can turn an attractive investment option into a nightmare for investors at times of financial crisis.

Choosing a Winning Strategy

Considering the aforementioned discussion, it is imperative for an investor to choose stocks that have a low debt-to-equity ratio. However, choosing stocks based solely on one financial metric might not fetch the desired outcome.

To ensure the maximum possible return from this strategy, we have expanded our screening procedure to include some other criteria.

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.

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 matter whether market conditions are good or bad, stocks with a Zacks Rank #1 or 2 have a proven history of success.

VGM Score of A or 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

Excluding stocks that have a negative or a zero debt-to-equity ratio, here are five of the final 21 stocks that made it through the screen.

Comfort Systems USA Inc. (FIX - Free Report) : This company offers mechanical installation, renovation, maintenance, repair, and replacement services for the mechanical services industry in the U.S. It carries a Zacks Rank #2 and witnessed an average positive earnings surprise of 15.83% in the trailing four quarters.

Tile Shop Holdings, Inc. (TTS - Free Report) : It operates as a specialty retailer of manufactured and natural stone tiles, setting and maintenance materials, and related accessories in the U.S. The company currently carries a Zacks Rank #2 and witnessed a positive earnings surprise of 15.09% on an average in the trailing four quarters.

AO Smith Corp. (AOS - Free Report) : This company manufactures and markets a range of water heaters, boilers, and other products for residential and commercial end markets. It witnessed a positive earnings surprise of 5.88% on an average in the trailing four quarters. It carries a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here.

Gibraltar Industries, Inc. (ROCK - Free Report) : This corporation manufactures and distributes building products. It carries a Zacks Rank #1 and witnessed a positive earnings surprise of 67.30% on an average in the trailing four quarters.

Fresh Del Monte Produce Inc. (FDP - Free Report) : This producer and distributor of fresh-cut fruit and vegetables carries a Zacks Rank #3 and witnessed a positive earnings surprise of 116.67% in its last quarter.

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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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