Buy These 5 Low Leverage Stocks Amid Coronavirus Outbreak

In finance, leverage refers to an investment strategy of using borrowed money by corporates. Now this borrowing can be done through debt or equity financing. Empirically, firms prefer debt financing over equity.

This is because when a company resorts to debt financing, it incurs fixed expenses in the form of interest payments for a specific time period.

However, in case of equity financing, a shareholder not only becomes a company’s partial owner but also gets a direct claim to its future profits.

Yet, higher debt financing is never desirable. Particularly, one should keep in mind that debt financing is 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 cause a corporation’s bankruptcy in the worst-case scenario.

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.

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 shows improved solvency for a company.

Currently, massive sell-offs are going on across global equity markets as investors remain skeptical amid the novel coronavirus outbreak that has created a worldwide demand-supply disruption. 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.

Zacks Investment Research

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Written By: Zacks Investment Research