Zacks.com Featured Highlights Include: Merit Medical, Pinnacle West, Steelcase, Southwest And EMCOR
Zacks Investment Research | Feb 06, 2019 10:07PM ET
For Immediate Release
Chicago, IL – February 7, 2019 - Stocks in this week’s article are Merit Medical Systems Inc. (NASDAQ:MMSI) , Pinnacle West Capital Corp. (NYSE:PNW) , Steelcase Inc. (NYSE:SCS) , Southwest Airlines Co. (NYSE:LUV) and EMCOR Group, Inc. (NYSE:EME) .
Bet on These 5 Low-Leverage Stocks to Escape Debt Traps
Per the theory of cost of capital, a company’s capital structure reflects a mix of debt and equity that is used to finance its capital projects. Now a comparative analysis of the same theory 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 more dearer for corporates.
In fact, statistics indicate that America, the richest economy in the world, is the biggest borrower too. Notably, huge spending on wars, big tax cuts and stimulating economic programs have all added to the nation’s burden over the years. According to the latest estimates given by the Congressional Budget Office, federal debt is projected to increase to nearly 100% of the economy’s GDP by 2028.
Yet, 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 the company's bottom line.
Nevertheless, this should not discourage investors from spending on U.S. stocks since debt has been part of the economy since its foundation and yet the country is a leader. What investors need to do is choose stocks with caution, thus avoiding those that carry high debt loads.
Empirically, several leverage ratios have been constructed to measure the exact amount of debt risk a company bears in order to safeguard investors from debt traps.
Debt-to-equity ratio is one such measure, perhaps the most popular one, which has been used 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 indicates improved solvency for a company.
With the Q4 earnings season in full swing currently, investors must be targeting companies with solid earnings growth projections. But, in the uncertain world of investment, markets can falter anytime, particularly affecting companies with a higher degree of financial leverage. Therefore, blindly investing in stocks displaying solid earnings growth without considering their debt level is not a wise move.
For the rest of this Screen of the Week article please visit Zacks.com at: Zacks Investment Research
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