5 Low Leverage Stocks To Buy Amid Rate Hike Woes

Debt financing is a common practice among corporates to ensure smooth operations and business expansion. This is because depending solely on retained earnings for business growth is impracticable.

Although companies may raise capital through equity financing, debt financing has always been a favored choice. While debt financing brings with it the liability of interest payment, it provides funding at lower rates than equity financing, especially in periods of historically low interest rates. Another perk of debt financing is that the interest on debt is tax deductible.

Yet, debt financing has its drawbacks. Since too much debt increases the cost of capital for the company, bearing huge debt tends to shoot up the company’s risk of bankruptcy, especially in times of economic crisis.

With the Federal Reserve having raised their benchmark interest rate last December and two more hikes expected by analysts this year, the debt scenario does not seem very favorable for U.S. stocks.

The fact that only a fortunate few can avoid taking debt, should not dissuade investors from betting on stocks. Instead, a prudent investor will try to pick stocks that are less financially leveraged as companies with high debt load are risky options.

And here comes the importance of leverage ratios, which have been constructed historically to save investors from debt traps. The debt-to-equity ratio is one such measure, perhaps the most popular one, to evaluate a company’s credit worthiness, for potential equity investments.

Analyzing Debt/Equity

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 implies that it has a more or less financially stable business, thereby making it a better investment pick.

With the Q4 reporting cycle about to begin, investors will tend to target stocks exhibiting solid earnings growth.

But choosing stocks that boast earnings growth only might not be a wise investment strategy. A higher degree of leverage can turn an attractive investment option into a nightmare in times of financial crisis.

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 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.

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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): Irrespective of market conditions, stocks with a Zacks Rank #1 or 2 have a proven history of success.

Zacks Investment Research

Written By: Zacks Investment Research