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While choosing stocks, investors should be careful about their debt level, which, if ignored, might cause a company to become insolvent in adverse situations. Therefore, if you don’t want to bet on risky stocks, then look for low-leverage stocks like TopBuild BLD, Essential Properties Realty Trust EPRT, Plains Group PAGP, Titan Machinery TITN and Saia (SAIA).
Basically, leverage is a term used to denote the practice of borrowing capital by companies to run their operations smoothly and expand the same. Such borrowings are primarily done through debt financing, although there remains an option for equity finance. This is probably due to the cheap and easy availability of debt over equity financing.
However, at times debt financing can be detrimental for a company’s prospects, especially when a company bears too much debt compared to its assets. So, one should look for stocks that are not heavily burdened with debt.
So, the next step should be how to identify such stocks that are not overburdened with debt as a debt-free stock is almost impossible to find.
To identify such stocks, 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 the fourth-quarter earnings cycle ahead of us, 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 we present our five picks out of the 11 stocks that made it through the screen.
TopBuild: It is an installer and distributor of insulation and other building products to the U.S. construction industry. BLD recently acquired Insulating Products, a residential and light commercial insulation distribution company. This transaction is expected to enhance the strength of TopBuild’s specialty distribution business.
TopBuild delivered an earnings surprise of 6.35%, on average, in the trailing four quarters and carries a Zacks Rank #2 currently. The Zacks Consensus Estimate for 2022 earnings has moved up 0.5% in the past 60 days.
Essential Properties Realty Trust: It is a real estate company that owns, acquires and manages single-tenant properties, which are net leased on a long-term basis to service-oriented and experience-based businesses. ERPT has recently hiked its dividend, thereby reflecting its financial stability.
Essential Properties currently carries a Zacks Rank #2. The company delivered an earnings surprise of 3.30% in the trailing four quarters, on average. ERPT boasts a long-term earnings growth rate of 12.3%.
Teradyne: It is a leading provider of automated test equipment, with a primary focus on the semiconductor test market. TER reported third-quarter 2021 revenue growth of 16% on a year-over-year basis, while its adjusted earnings improved 35%.
Teradyne came up with a four-quarter earnings surprise of 9.32%, on average, and carries a Zacks Rank of 2. It boasts a long-term earnings growth rate of 14.9%. You can see the complete list of today’s Zacks #1 Rank stocks here.
Titan Machinery: It is a multi-unit business, which owns and operates a network of full-service agricultural and construction equipment stores in the United States and Europe. TITN’s fiscal third-quarter revenues grew 37% year over year, while adjusted earnings improved 81.1%.
Currently, Titan Machinery sports a Zacks Rank of 1. It delivered a four-quarter earnings surprise of 93.3%, on average. Its fiscal 2022 earnings estimate has improved 15.7% over the past 60 days.
Saia: It is a leading transportation company that provides a variety of trucking transportation and supply chain solutions to a broad range of industries, including the retail, petrochemical and manufacturing industries. SAIA recently partnered with Daimler Trucks North America to test a battery-electric Freightliner eM2 box truck in its Portland, Oregon pickup and delivery operations. This would help the company integrate electric vehicles into its fleet.
Saia currently sports a Zacks Rank #1 and delivered a four-quarter earnings surprise of 14.75%, on average. Its long-term earnings growth rate estimate is 35.7%.
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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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Titan Machinery Inc. (TITN) : Free Stock Analysis Report
TopBuild Corp. (BLD) : Free Stock Analysis Report
Plains Group Holdings, L.P. (PAGP) : Free Stock Analysis Report
Saia, Inc. (SAIA) : Free Stock Analysis Report
Essential Properties Realty Trust, Inc. (EPRT) : Free Stock Analysis Report
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