The coronavirus outbreak has sent the global economy on a roller-coaster ride, particularly from March 2020. Consequently, the stock market has also been volatile.
Investors should choose stocks wisely amid these uncertain times as debt-ridden stocks bear high risk of solvency.
However, borrowing funds is a very common phenomenon among companies. For such borrowings, most often companies resort to debt financing though there is also the option of equity financing.
The reason behind such preference is the easy and cheap availability of debt compared to equity.
Yet, debt financing has its share of drawbacks. The problem arises when the amount of debt a company bears becomes exorbitant. A high degree of financial leverage means high interest payments, which affect the company's bottom line.
Therefore, to safeguard one’s portfolio from notable losses, the real challenge for an investor is determining whether the organization’s debt level is sustainable. A debt-free corporation is rare to find. Historically several leverage ratios have been developed to measure the amount of debt a company bears and the debt-to-equity ratio is one of the most common ratios.
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 shows improved solvency for a company.
With Q2 earnings knocking on our doors, investors may intend to choose companies that have exhibited solid earnings growth. However, blindly pursuing high earnings yielding stocks, which have a high debt-to-equity ratio, might drain all your money before you know.
The Winning Strategy
Considering the aforementioned factors, it is prudent to choose stocks with a low debt-to-equity ratio to ensure steady 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 or 2 have a proven history of success.
Excluding stocks that have a negative or a zero debt-to-equity ratio, here are five of the 23 stocks that made it through the screen.
Boise Cascade BCC: It operates as a wood products manufacturer and building materials distributor.The company delivered four-quarter earnings surprise of 36.96%, on average and currently sports a Zacks Rank #1.
Lakeland Industries LAKE: It is engaged in the manufacturing of protective clothing to help improve the quality of safety for the industrial workforce. The company currently carries a Zacks Rank #2 and delivered four-quarter earnings surprise of 722.92%, on average.
NextEra Energy NEE: It is a public utility holding company engaged in the generation, transmission, distribution, and sale of electric energy. The company came up with four-quarter earnings surprise of 2.39%, on average and carries a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here.
FormFactor FORM: It is an OEM of automated wafer probe cards used in the back-end portion of the semiconductor manufacturing process. Currently, the company carries a Zacks Rank #2 and came up with four-quarter earnings surprise of 25.14%, on average.
West Pharmaceutical Services WST: It operates as a global drug delivery technology company. It currently holds a Zacks Rank #2 and delivered four-quarter earnings surprise of 17.99%, on average.
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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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FormFactor, Inc. (FORM): Free Stock Analysis Report
NextEra Energy, Inc. (NEE): Free Stock Analysis Report
West Pharmaceutical Services, Inc. (WST): Free Stock Analysis Report
Lakeland Industries, Inc. (LAKE): Free Stock Analysis Report
Boise Cascade, L.L.C. (BCC): Free Stock Analysis Report
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.