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There has been a decent uptick in the market over the past couple of trading sessions as opposed to the downturn that the Wall Street witnessed last week, thanks to concerns about the fast-spreading delta variant. Instead of getting spooked by such fluctuations, which are nothing new for the global bourses, investors prefer to play safe.
And here comes the concept of leverage. Amid the pandemic-led uncertainties, investors are likely to opt for safe-bet investments and for that in-depth knowledge of leverage is needed.
Notably, leverage refers to the use of exogenous funds by companies to run their operations smoothly and expand the same, since no company has unlimited capital. Now, this borrowing can be done either through equity financing or debt financing.
Statistically, it has been seen that debt financing is preferred over equity because of its easy and cheap availability.
However, a company with too much of debt is not a desirable investment option. This is because, too much of debt brings with it the burden of interest payment. So, to avoid considerable losses in your portfolio, one should always avoid companies that resort to exorbitant debt financing.
Therefore, the crux of safe investment lies in choosing a company that is not overburdened with debt as a debt-free stock is almost impossible to find.
For identifying such a safe bet, different ratios are being used by investors to measure the debt a company bears. One such ratio is debt-to-equity ratio.
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 second-quarter earnings season already have started, investors must be eyeing stocks that exhibited solid earnings growth in the past couple of 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.
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 (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 29 stocks that made it through the screen.
Toronto Dominion Bank TD: It is a Canadian chartered bank and offers a wide range of business and consumer services. The company delivered an earnings surprise of 21.60%, on average, in the trailing four quarters and carries a Zacks Rank #2 currently.
Textron TXT: It is a global multi-industry company that manufactures aircraft, automotive engine components and industrial tools. The company currently holds a Zacks Rank #2 and delivered an earnings surprise of 75.88% in the trailing four quarters, on average.
Selective Insurance Group SIGI: It operates as a P&C insurer and thus offers insurance products and services across the United States. The company came up with a four-quarter earnings surprise of 35.12%, on average, and has a Zacks Rank of 2. You can see the complete list of today’s Zacks #1 Rank stocks here.
AdvanSix ASIX: It is a producer and supplier of Nylon 6 materials. Currently, the company sports a Zacks Rank of 1 and came up with a four-quarter earnings surprise of 45.47%, on average.
Quanex Building Products Corporation NX: It designs and produces energy-efficient fenestration products in addition to kitchen and bath cabinet components. The company currently sports a Zacks Rank #1 and delivered a four-quarter earnings surprise of 444.09%, 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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Textron Inc. (TXT) : Free Stock Analysis Report
Toronto Dominion Bank The (TD) : Free Stock Analysis Report
Selective Insurance Group, Inc. (SIGI) : Free Stock Analysis Report
Quanex Building Products Corporation (NX) : Free Stock Analysis Report
AdvanSix Inc. (ASIX) : Free Stock Analysis Report
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