Investors looked a bit unnerved following Fed Chairman Jerome Powell’s recent commentary on fighting inflation and raising interest rates. Powell said, “Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labor market conditions. While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses.”
Continuous increase in benchmark interest rates to tackle inflationary headwinds may inflict some pain on the economy. Powell’s tough comments did not go well down with investors.
So, as you scramble to rebalance the portfolio, investment decisions solely based on sales and earnings numbers may not just be enough. Sometimes, a stock gets a boost if these numbers climb year over year or surpass estimates in a particular quarter, thus offering a great opportunity for an investor with a shorter horizon to cash in on. But if you seek long-term returns, investments backed only by sales and earnings numbers may not yield the desired results.
A critical analysis of a company’s financial background is a prerequisite for an informed investment decision. Here, coverage ratios that determine whether a company is sound enough to meet its financial obligations play a crucial role. The higher the ratio, the better. The focus of this article is on “Interest Coverage,” which is one such ratio.
Interest Coverage Ratio = Earnings before Interest & Taxes (EBIT) divided by Interest Expense.
Why Interest Coverage Ratio?
The interest coverage ratio is used to determine how effectively a company can pay the interest charges on its debt.
Debt, which is crucial for most of the companies to finance operations, comes at a cost called interest. Interest expense has a direct bearing on the profitability of a company and its creditworthiness depends on how effectively it meets interest obligations. Therefore, Interest Coverage Ratio is one of the important criteria to factor in before making any investment decision.
The interest coverage ratio suggests the number of times the interest could be paid from earnings and gauges the margin of safety a firm carries for paying interest.
An interest coverage ratio lower than 1.0 implies that the company is unable to fulfill 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.
Dillard's, Inc. DDS, ArcBest Corporation ARCB, H&R Block, Inc. HRB and Lincoln Electric Holdings, Inc. LECO boast an impressive interest coverage ratio.
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. This 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 four of the 18 stocks that qualified the screening:
Dillard's, which operates retail department stores, sports a Zacks Rank #1 and has a VGM Score of A. Its expected EPS growth rate for three-five years is 14.6%. You can see the complete list of today’s Zacks #1 Rank stocks here.
The Zacks Consensus Estimate for Dillard's current financial year sales suggests growth of 6% from the year-ago period. DDS has a trailing four-quarter earnings surprise of 215%, on average. The stock has zoomed 53.3% in the past year.
ArcBest, which provides freight transportation and integrated logistics services, carries a Zacks Rank #2 and has a VGM Score of A. Its expected EPS growth rate for three-five years is 26.5%.
The Zacks Consensus Estimate for ArcBest's current financial year sales and EPS suggests growth of 36.7% and 68.5%, respectively, from the year-ago period. ArcBest has a trailing four-quarter earnings surprise of 22.3%, on average. The stock has advanced 21.3% in the past year.
H&R Block, which offers assisted income tax return preparation and related services, carries a Zacks Rank #2 and has a VGM Score of B. Its expected EPS growth rate for three-five years is 12.5%.
The Zacks Consensus Estimate for H&R Block's current financial year sales and EPS suggests growth of 2.7% and 7.7%, respectively, from the year-ago period. HRB has a trailing four-quarter earnings surprise of 19.2%, on average. The stock has rallied 71.1% in the past year.
Lincoln Electric Holdings, which designs, develops, manufactures, and sells welding, cutting, and brazing products globally, carries a Zacks Rank #2 and has a VGM Score of B. Its expected EPS growth rate for three-five years is 15%.
The Zacks Consensus Estimate for Lincoln Electric Holdings' current financial year sales and EPS suggests growth of 16.4% and 31.8%, respectively, from the year-ago period. Lincoln Electric Holdings has a trailing four-quarter earnings surprise of 10.9%, on average. The stock has risen 0.6% in the past year.
You can get the rest of the stocks on this list by signing up now for your 2-week free trial to the Research Wizard and start using this screen in your own trading. Further, you can also create your own strategies and backtest them first before taking the investment plunge.
The Research Wizard is a great place to begin. It's easy to use. Everything is in plain language. And it's very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open up the Research Wizard, plug your finds in, and see what gems come out.
Click here to sign up for a free trial to the Research Wizard today.
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.
Special Report: The Top 5 IPOs for Your Portfolio
Today, you have a chance to get in on the ground floor of one of the best investment opportunities of the year. As the world continues to benefit from an ever-evolving internet, a handful of innovative tech companies are on the brink of reaping immense rewards - and you can put yourself in a position to cash in. One is set to disrupt the online communication industry. Brilliantly designed for creating online communities, this stock is poised to explode when made public. With the strength of our economy and record amounts of cash flooding into IPOs, you don’t want to miss this opportunity.>>See Zacks’ Hottest IPOs Now
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report
Dillard's, Inc. (DDS): Free Stock Analysis Report
Lincoln Electric Holdings, Inc. (LECO): Free Stock Analysis Report
H&R Block, Inc. (HRB): Free Stock Analysis Report
ArcBest Corporation (ARCB): Free Stock Analysis Report
To read this article on Zacks.com click here.
Zacks Investment Research
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.