Buy These 5 Low Leverage Stocks If You Want To Play Safe

Leverage is a well-known business strategy, which involves usage of borrowed funds to finance the purchase of inventory, equipment as well as other company assets. Companies can obtain such funds either using debt or equity.

Statistically, companies prefer debt over equity. This is because debt is available easily and is cheaper than equity financing. Moreover, in case of debt financing, notwithstanding whether the interest charges are from a loan or line of credit, the interest payments are tax deductible. However, in case of equity financing, a shareholder not only becomes a partial owner of the company but develops a direct claim on the company’s future profits as well.

Nevertheless, debt financing has its share of drawbacks. Especially, companies with large debt loads are more vulnerable during economic downturns and can even go bankrupt in the worst-case scenario. A high degree of financial leverage means high interest payments, which affect a company's bottom line.

Since existence of a debt-free company is rare, to safeguard their portfolio from notable losses, the real challenge for an investor is determining whether an organization’s debt level is sustainable. To gauge how risky a company is, potential equity investors look at leverage ratios. Debt-to-equity ratio is one such measure, perhaps the most popular one, to evaluate a company’s creditworthiness 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 shows improved solvency for a company.

With the Q2 reporting cycle approaching its end, investors must be eyeing companies that have exhibited solid earnings growth in the past couple of quarters. But, in the uncertain world of investment, markets can falter anytime, particularly affecting companies with a higher degree of financial leverage. Therefore, investing in stocks displaying solid earnings growth without considering their debt level is not a wise move.

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.

Zacks Investment Research

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Written By: Zacks Investment Research