U.S. stocks slipped at the start of this week on account of growing concerns about the nation’s trade economics. Notably, stocks were southbound after China canceled trade talks with the United States, warning American officials to stop threatening it with tariff expansion. This fueled fresh trade tensions between the two nations, thereby spooking investors.
This indicates how fragile the stock market can be at times of crisis and the bubble may burst at any moment. Therefore, an investor should be extra cautious while choosing stocks and keep his or her portfolio as less risky as possible.
So the most obvious question at this point is “Which stocks are risky?” No equity is risk free. Yet, to avoid maximum loss, one should know the art of identifying less risky stocks and one such strategy is to opt for low leverage stocks.
Now, leverage, otherwise termed as debt financing, is the use of exogenous funds by corporations to run their operations smoothly and expand the same. Although there is option for equity financing, historically debt financing has been preferred over equity because of its easy and cheap availability.
Another perk of debt financing is that the interest on debt is tax deductible.
However, one should keep in mind that debt financing remains 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 lead to a corporation’s bankruptcy in a worst case scenario.
This is because while debt brings with it the capacity to spend a little bit more, it also carries the burden of repayment with additional interest in the future. As a result, prudent investors try to avoid companies with large debt loads since they are more vulnerable during economic downturns.
So, the crux of safe investment lies in identifying low leverage stocks.
And here comes the importance of leverage ratios, which have been constructed historically to safeguard investors from becoming victims of debt trap. Debt-to-equity ratio is one such measure, perhaps the most popular one, to evaluate a company’s creditworthiness for potential equity investments.
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 indicates improved solvency for a company.
With the third quarter coming to an end, investors must be targeting stocks that exhibited solid earnings growth in prior quarters. 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.
Thus, it will be wise for investors to select companies with low leverage. These are financially more secure and immune to financial bankruptcy.
The Winning Strategy
Considering the aforementioned factors, it is wise to choose stocks with a low debt-to-equity ratio to ensure safe 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 (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 five of the 48 stocks that made it through the screen.
Werner Enterprises WERN: The company is a premier transportation and logistics provider, engaged in hauling truckload shipments of general commodities in both interstate and intrastate commerce. It pulled off an average positive earnings surprise of 7.32% in the trailing four quarters and currently sports a Zacks Rank #1.
Huntington Ingalls Industries HII: It designs, builds and maintains nuclear-powered ships such as aircraft carriers and submarines and non-nuclear ships such as surface combatants, expeditionary warfare/amphibious assault and coastal defense surface ships. The company holds a Zacks Rank #2 and delivered an average positive earnings surprise of 9.48% in the trailing four quarters.
Avnet AVT: The company is one of the world’s largest distributors of electronic components and computer products. It pulled off an average positive earnings surprise of 5.92% in the trailing four quarters and currently carries a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here.
Forward Air FWRD: It is a leading provider of ground transportation and related logistics services to the North American air freight and expedited LTL market. The company carries a Zacks Rank #2 and pulled off an average positive earnings surprise of 5.72% in the trailing four quarters.
Fidelity National Financial FNF: It is a leading provider of title insurance, specialty insurance and claims management services. The company currently holds a Zacks Rank #2 and delivered an average positive earnings surprise of 2.80% in the trailing four quarters.
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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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Werner Enterprises, Inc. (WERN) : Free Stock Analysis Report
Forward Air Corporation (FWRD) : Free Stock Analysis Report
Huntington Ingalls Industries, Inc. (HII) : Free Stock Analysis Report
Avnet, Inc. (AVT) : Free Stock Analysis Report
Fidelity National Financial, Inc. (FNF) : Free Stock Analysis Report
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