Investors should know that uncertainty can hit the global equity market anytime and therefore it is better to take measures beforehand than repent later. This is why investors need to be acquainted with leverage.
Notably, leverage, otherwise termed as debt financing, is the use of exogenous funds by corporations to run their operations smoothly and expand the same. Although there is option for equity financing, historically, debt financing has been preferred over equity because of its easy and cheap availability.
However, one should keep in mind that debt financing remains a feasible option as long as the companies succeed in generating a higher rate of return compared to the interest rate. Exorbitant debt financing might even lead to a corporation’s bankruptcy in a worst case scenario.
Therefore, one can safely invest in a stock as long as it bears a low level of debt.
And here comes the importance of leverage ratios, which have been constructed to safeguard investors from becoming victims of debt trap. Debt-to-equity ratio is one such measure, perhaps the most popular one, to evaluate a company’s creditworthiness for potential equity investments.
Debt-to-Equity Ratio = Total Liabilities/Shareholders’ Equity
This metric is a liquidity ratio that indicates the amount of financial risk a company bears. A company with a lower debt-to-equity ratio indicates improved solvency for a company.
As the third-quarter reporting season is in full swing, investors must be eyeing stocks that exhibited solid earnings growth in the prior quarters. But if a stock bears a high debt-to-equity ratio, in times of economic downturns, its so-called booming earnings picture might turn into a nightmare.
Thus, it will be wise for investors to select companies with low leverage. These are financially more secure and immune to financial bankruptcy.
The Winning Strategy
Considering the aforementioned factors, it is wise to choose stocks with a low debt-to-equity ratio to ensure safe returns.
However, an investment strategy based solely on debt-to-equity ratio might not fetch the desired outcome. To choose stocks that have the potential to give you steady returns, we have expanded our screening criteria to include some other factors.
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.
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 (Strong Buy) or 2 (Buy) offer the best upside potential.
Estimated One-Year EPS Growth F(1)/F(0) greater than 5: This shows earnings growth expectation.
Zacks Rank #1 or 2: Irrespective of market conditions, stocks with a Zacks Rank #1 (Strong Buy) or 2 (Buy) have a proven history of success.
Excluding stocks that have a negative or a zero debt-to-equity ratio, here are five of the 24 stocks that made it through the screen.
Werner Enterprises (WERN - Free Report) : The company is a premier transportation and logistics provider, engaged in hauling truckload shipments of general commodities in both interstate and intrastate commerce. It pulled off an average positive earnings surprise of 10.60% in the trailing four quarters and currently carries a Zacks Rank #2.
Amedysis, Inc. (AMED - Free Report) : It provides home health and hospice services throughout the United States to the growing chronic, co-morbid and aging American population. The company holds a Zacks Rank #2 and delivered an average positive earnings surprise of 16.55% in the trailing four quarters.
Haverty Furniture Companies (HVT - Free Report) : The company is a full-service home furnishings retailer. It pulled off an average positive earnings surprise of 24.10% in the trailing four quarters and currently carries a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here.
Energen Corp. : It is a leading oil and natural gas exploration and production company. Most of the company’s production consists of oil. The company carries a Zacks Rank #2. It pulled off an average positive earnings surprise of 23.71% in the trailing four quarters.
MGIC Investment Corp (MTG - Free Report) : It is the leading provider of private mortgage insurance coverage in the United States to the home mortgage lending industry. The company currently holds a Zacks Rank #2 and delivered an average positive earnings surprise of 34.32% in the trailing four quarters.
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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.