The U.S. stock market is going through tumultuous times as investors have been spooked by coronavirus-led recession fears and are thus selling off equities to keep maximum cash in hand. Now, it is obvious that following the prolonged lockdown in many parts of the world and transport restrictions, only a handful of industries continue to thrive.
However, this should give no reason to investors to totally refrain from equity transactions. In fact, this is a good time to go for safe bets so that in the event of any further market turmoil the stockholders do not lose significantly. And here comes the strategy of choosing low leverage stocks.
Now, leverage is an investment strategy of using borrowed money by corporates, which is mostly done through debt financing.
However,at times too much of leverage is harmful for a company’s growth.
This is because a high degree of financial leverage means heavy interest payments, which affect a company’s bottom line.
Since a debt-free company is rare to find, measuring the debt level of a company is an important point of consideration while making an investment decision. Historically, several leverage ratios have been developed to compute the amount of debt a company bears. 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.
Amid the novel coronavirus outbreak that has created a worldwide demand-supply disruption, sell-offs are still going on across global equity markets.Nevertheless, this should not discourage investors to spend in the stock market altogether. Instead, their investments should include stocks that are not highly leveraged.
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 five of the 22 stocks that made it through the screen.
FormFactor FORM: It is an original equipment manufacturer of automated wafer probe cards used in the back-end portion of the semiconductor manufacturing process. The company delivered positive earnings surprise of 13.63% on average in the last four quarters and currently carries a Zacks Rank #2.
AeroVironment AVAV: It is a manufacturer of unmanned aircraft systems and tactical missile systems used for surveillance and reconnaissance. The company carries a Zacks Rank #2 and delivered positive surprise 5.72% on average in the trailing four quarters.
Costco Wholesale COST: It sells high volumes of foods and general merchandise (including household products and appliances) at discounted prices through membership warehouses. The company came up with average four-quarter beat of 3.10% and carries a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here.
Chemed Corporation CHE: It offers diversified business operations including non-curative hospice care as well as plumbing and drain cleaning services. This Zacks #1 Ranked stock pulled off average positive earnings surprise of 3.36% in the preceding four quarters.
Tandem Diabetics Care TNDM: It develops insulin pumps along with other products that help in diabetes management.. The company has a Zacks Rank #2, while its four-quarter positive earnings surprise is 78.70%, 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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FormFactor, Inc. (FORM) : Free Stock Analysis Report
Costco Wholesale Corporation (COST) : Free Stock Analysis Report
AeroVironment, Inc. (AVAV) : Free Stock Analysis Report
Chemed Corporation (CHE) : Free Stock Analysis Report
Tandem Diabetes Care, Inc. (TNDM) : Free Stock Analysis Report
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