To stay away from the clasps of bankruptcy investors, often go for safe-bet companies like
Costco Wholesale
COST
,
Axcelis Technologies
ACLS
,
Earthstone Energy
ESTE
,
Philips 66
PSX
and
Teradyne
TER
that boast low leverage.
Notably, companies require exogenous funds to ensure smooth operations and expansion of business, as no organization in this world has abundant capital. These funds can be obtained through debt or equity. Here comes the concept of leverage, which is basically the usage of debt for such purposes.
Now, although there remains a choice for companies to either select debt or equity financing, most of them go for debt financing since it is cheap and easily available compared to equity financing.
Nevertheless, debt financing has its share of drawbacks. Particularly, one should keep in mind that debt financing is 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 cause a corporation’s bankruptcy in a worst-case scenario
Since a high degree of financial leverage means heavy interest payments, investors tend to choose companies that are not burdened with debt.
Therefore, to stay away from the trap of bankruptcy, one must be aware of a particular company’s debt level before investing in its shares, since you can hardly find a totally debt-free company.
Here comes the concept of leverage. In the complex world of investment, understanding the amount of financial leverage a company bears is crucial. This is because the higher the degree of financial leverage, the higher is the interest payment for the capital borrowed.
For this purpose, one must be able to measure a company’s debt level, thereby enabling an investor to choose a low-leverage stock, which is likely to bear less risk. The debt-to-equity ratio is one such metric that has been used frequently to measure the leverage of a company.
Analyzing Debt/Equity
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 the third-quarter earnings season almost coming to an end, investors must be eyeing stocks that have exhibited solid earnings growth in the recent past. 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.
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 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 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 the five of the 29 stocks that made it through the screen.
Costco Wholesale:
It sells high volumes of foods and general merchandise (including household products and appliances) at discounted prices through membership warehouses. Costco continues to be one of the dominant warehouse retailers based on the expanse and quality of merchandise offered.
Costco delivered an earnings surprise of 7.66%, on average, in the trailing four quarters and carries a Zacks Rank #2 currently.Its long-term earnings growth rate estimate is pegged at 8.6%.
Axcelis Technologies
: It is a leading producer of ion implantation equipment used in the fabrication of semiconductors. The company’s innovative source technology, featuring H2 as a co-gas with fluorine based dopants, will optimize implanter performance by reducing glitches, reducing tungsten metal contamination and increasing source lifetimes.
Axcelis currently carries a Zacks Rank #2. The company delivered an earnings surprise of 24.08% in the trailing four quarters, on average.
Earthstone Energy
: It is a growth-oriented independent energy company engaged in developing and operating oil and gas properties. In November 2021, Earthstone completed the previously announced acquisition of privately held operated assets located in the Midland Basin from Foreland Investments LP and from BCC-Foreland LLC, which held well-bore interests in certain of the producing wells operated by Foreland.
Earthstone came up with a four-quarter earnings surprise of 93.17%, on average, and sports a Zacks Rank of 1. You can see
the complete list of today’s Zacks #1 Rank stocks here.
Philips 66
: Its operations incorporate refining, midstream, marketing and specialties, and chemicals. The company recently announced that it plans to convert its Alliance Refinery in Belle Chasse, La., to a terminal facility. The conversion is expected to take place in 2022.
Currently, Philips 66 holds a Zacks Rank of 1. It delivered a four-quarter earnings surprise of 19.66%, on average.
Teradyne
: It is a leading provider of automated test equipment, with a particular focus on the semiconductor test market. Teradyne’s third-quarter 2021 adjusted earnings of $1.59, which grew 35% year-over-year.
Teradyne currently carries a Zacks Rank #2 and delivered a four-quarter earnings surprise of 9.32%, on average. Its long-term earnings growth rate estimate is pegged at 8.6%.
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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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