Leverage, better known as financial leverage, refers to the use of debt financing by corporations to boost its business. Although companies have the option to resort to equity financing, debt financing is a more frequently chosen option. This is because equity financing is more costly.
Naturally debt financing is a well practiced business strategy among majority of the companies in the stock market. However, uncertainty can hit the global market anytime.
In fact, if we consider the current scenario, the picture is not a very bright one. U.S. stocks took a dip last week with the S&P 500 index recording its biggest one-day fall on Thursday since May.
This temporarily marred positive sentiments in the market, courtesy of the nation’s improving macroeconomic indicators under President Trump’s reign. Nevertheless, investing in the stock market hardly backfires provided one is cautious.
Usually, companies with a lower level of debt are considered safe bets. This is because highly leveraged stocks are vulnerable in times of volatility.
So the crux of safe investment lies in identifying low leveraged stocks. Using financial leverage ratio, one can easily determine low-leveraged stocks. One of the most popular leverage ratios is debt-to-equity ratio.
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 implies that it has a more or less financially stable business, thereby making it a more worthy investment opportunity.
With the second-quarter earnings season nearing its end, investors must be gearing up for investing in growth stocks. However, blindly pursuing high earnings yielding stocks might be a drain on your resources if these have a high debt-to-equity ratio.
This is because a high debt-to-equity ratio indicates a huge level of repayment that the company has to make in connection with the large debt amount, which had once boosted its earnings growth. This makes the company’s so-called solid earnings very volatile.
Therefore to avoid losses, it is wise to go for stocks bearing low debt-to-equity ratio.
The Winning Strategy
Given the fact that uncertainty can hit the global market anytime, choosing low leverage stocks is considered a safe strategy.
However, an investment strategy based solely on the 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 criteria, as discussed below.
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.
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, following are five of the 21 stocks that made it through the screen.
Big Lots, Inc. (NYSE:BIG): It is one of the leading value retailers specializing in closeout merchandise and toys. The company carries a Zacks Rank #2 and has delivered an average positive earnings surprise of 82.98% in the trailing four quarters.
Honda Motor Co Ltd (NYSE:HMC): This company manufactures a wide range of products, including motorcycles, ATVs, generators, marine engines, lawn and garden equipment and automobiles. It carries a Zacks Rank # 1 and came up with an average positive earnings surprise of 69.20% in the trailing four quarters.
EMCOR Group Inc (NYSE:EME): This corporation is engaged in design, integration, installation, start-up, testing, operation and maintenance of complex mechanical and electrical systems. It delivered an average positive earnings surprise of 11.69% in the trailing four quarters and carries a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here.
Manulife Financial Corporation (USA) (NYSE:MFC): It is engaged in providing financial protection products and investment management services. The company carries a Zacks Rank #1 and came up with an average positive earnings surprise of 11.08% in the trailing four quarters.
Deutsche Post AG (OTCMKTS:DPSGY): It provides logistics services primarily in Germany, Europe, America, Asia Pacific and Other regions. The company carries a Zacks Rank #2 and came up with an average positive earnings surprise of 9.55% 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.
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