U.S. stocks bounced back to record highs on yesterday, as tech stocks recovered substantially after suffering a two-day dip. Moreover, most analysts are anticipating another rate hike with the Federal Reserve’s latest monetary policy decision due today. This reflects a favorable economic scenario in the U.S., which in turn induced the positive sentiment in the market.
However, a record number of investors are skeptical as they fear that the market is overvalued at present and doubt whether this momentum will continue in the long run. In fact, as per a survey of fund managers released by Bank of America Merrill Lynch – a net 44% of investors—believe equities are too expensive right now.
Now an overpriced stock market is something that all investors are afraid of. Historically, such overvalued markets have given rise to stock market bubbles that bankrupted thousands of unfortunate investors.
Moreover, a few investors are also skeptical about the Fed’s plan to start reducing its huge portfolio of bonds. Amid such uncertainty pertaining to long-term stability of the market, it is best to invest prudently.
Since sudden variability can hit the global markets any time, it is wise to choose less risky stocks. Companies with a lower level of debt are considered safe bets. This is because highly leveraged stocks are vulnerable in times of volatility
Using financial leverage ratio, one can easily determine low-leveraged stocks. One of the most popular leverage ratios is the 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 lower debt-to-equity ratio implies a more financially stable business, thereby making it a more worthy investment opportunity.
With the second quarter earnings cycle set to hit the road next month, investors must be gearing up to chase stocks exhibiting solid growth. However, blindly choosing growth stocks also has its disadvantage if their debt levels are not taken into consideration. Therefore, it is needless to say that if you want to play safe, go for low-leveraged stocks.
The Winning Strategy
Considering the aforementioned discussion, it is imperative for a sensible investor to choose stocks that have a low debt-to-equity ratio.
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.
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.
Estimated One-Year EPS Growth F(1)/F(0) greater than 5: This shows earnings growth expectation.
Zacks Rank #1 (Strong Buy) or #2 (Buy): No matter whether market conditions are good or bad, stocks with a Zacks Rank #1 or 2 have a proven history of success.
VGMScore of A or B: Our research shows that stocks with a VGM Score of ‘A’ or ‘B’ when combined with a Zacks Rank #1 or 2 offer the best upside potential.
Excluding stocks that have a negative or a zero debt-to-equity ratio, here are five of the 17 stocks that made it through the screen.
Darden Restaurants, Inc. DRI: This company is the world's largest casual dining restaurant and engages in the ownership and operation of casual dining restaurants in the U.S. and Canada. It carries a Zacks Rank #2 and witnessed an average positive earnings surprise of 3.35% in the trailing four quarters.
EMCOR Group, Inc. EME: It is one of the leading providers of mechanical and electrical construction, industrial and energy infrastructure, and building services for a diverse range of businesses. EMCOR carries a Zacks Rank #2 and witnessed an average positive earnings surprise of 15.45% in the trailing four quarters.
Anthem, Inc. ANTM: This corporation operates as a health benefits company in the U.S. It witnessed an average positive earnings surprise of 8.36% in the trailing four quarters and carries a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here.
Humana Inc. HUM: It is one of the largest health care plan providers in the U.S. The company carries a Zacks Rank #2 and witnessed an average positive earnings surprise of 3.75% in the trailing four quarters.
Vodafone Group PLC VOD: It is the world's largest international mobile communications firm. It primarily operates digital and analog cellular telephone networks of Vodafone. It carries a Zacks Rank #2 and has a long-term earnings growth rate of 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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