Buy These 5 Low Leverage Stocks To Keep Losses At Bay

Leverage is an investment strategy adopted by corporations wherein borrowed capital is used to expand operations and amplify possible returns from risk capital. Per the theory of cost of capital, a company’s capital structure reflects a mix of debt and equity that is used to finance capital projects.

Now a comparative analysis of the theory of cost of capital reveals that most companies prefer debt financing over equity since debt is cheaper, especially in periods of low interest rates.

This is because when a company resorts to debt financing, it takes on 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 partial owner of the company but develops a direct claim on the company’s future profits as well. So, debt financing remains the preferred option for corporates.

However, debt financing has its share of drawbacks. The problem arises when leverage, referred to as the amount of debt a company bears, becomes exorbitant. A high degree of financial leverage means high interest payments, which affect a company's bottom line.

Therefore, choosing a less debt-ridden stock should be an appropriate option for a risk-averse investor. And here comes the importance of leverage ratios, which can measure the exact amount of debt risk a company bears. 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.

Investors must be looking for stocks exhibiting solid earnings growth in the last couple of quarters. However, blindly 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 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