"Leverage is great when it works, and when it doesn't work, it
creates a lot of issues" - Marc Lasry.
The term 'leverage' is common in the business world. But when it
comes to investment, this term holds the key to the treasures
hidden in a stock. Although debt financing is nothing new for big
corporations to fund their operations, the degree of financial
leverage that a business bears always catches the attention of
This is because in the uncertain world of investments, it is
difficult to predict macroeconomic and competitive changes that
often lead markets to significant downturns. Companies with a
higher degree of financial leverage are more prone to incur
significant losses during such downturns, and even bankruptcy in
the worst case scenario.
In order to avoid such risks, there are varied leverage ratios
that an investor can use to understand a company's capital
structure before investing in its stock. The most popular among
these is debt-to-equity ratio.
This metric is a basically a solvency ratio that measures the
extent of financial leverage that a company is bearing. A lower
debt-to-equity ratio greatly contributes to an investor's
confidence in a company's financial stability.
Understanding the Formula
Debt-to-Equity Ratio = Total Liabilities/Shareholders'
A higher debt-to-equity ratio implies a more risky business and
what better time to remind investors of this than the peak
first-quarter earnings season when they must be flocking to high
earnings-yielding companies. However, blindly pursuing such a stock
might drain all your money before you know if it bears a high
This is because a high debt-to-equity ratio indicates more
leverage which always tends to increase the volatility of a
company's earnings and cash flows; thereby raising the variability
of return on its equity.
The Winning Strategy
It is not wise to choose an investment strategy based solely on
the debt-to-equity ratio. To choose stocks that also have the
potential to give you steady returns, we have expanded our
screening procedure to include some other criteria.
Here is the final screen:
Debt/Equity less than X-Industry Median:
Thestocks are less leveragedcompared to their industry
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
Asubstantial trading volume ensures that the stock is easily
Percentage Change in EPS F(0)/F(-1) greater than X-Industry
Earnings growth add to optimism, leading to a stock's price
Estimated One-Year EPS Growth F(1)/F(0) greater than
This shows earnings growth expectation.
Zacks Rank #1 (Strong Buy) or #2 (Buy):
whether market conditions are good or bad, stocks with a Zacks Rank
#1 (Strong Buy) or 2 (Buy) have a proven history of success.
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
Although 31 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 18 that have a favorable
- Skechers U.S.A., Inc. (
- Cash America International, Inc. (
- Universal Forest Products Inc. (
- Comfort Systems USA Inc. (
- CONE Midstream Partners LP (
Get the rest of the stocks on the list and start putting this
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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
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