Bet on These 5 Low Leverage Stocks to Avoid Debt Traps

Leverage, in particular financial leverage, is a popular investment strategy of using borrowed capital to finance the expansion of business, purchase of inventory and other assets as well as support other aspects of business operations.

While there exists option for equity financing, historically, debt financing has achieved more popularity among corporations when compared to equity financing. This is because, on availing debt financing, the company’s equity does not get diluted as a result of issuing more shares of the stock. In other words, the borrower has no claim in the company’s shares.

Another perk of debt financing is that the interest on debt is tax deductible.

Yet, debt financing has got its own drawbacks. It tends to shoot up the company’s risk of bankruptcy. This is because companies with high debt loads are more vulnerable during economic downturns.

In fact, the related amount of interest expense may overwhelm the borrower if it does not earn sufficient returns to offset the interest expense. This is particularly a problem when interest rates rise or the returns from assets decline.With the current macroeconomic scenario in the United States being in favor of interest rate hikes, the market seems to be not so suitable for borrowers.

Nevertheless, this does not mean that equity investments are too risky and investing in stocks might not lead to perceived returns. After all, in spite of such high debt levels, the United States remains the largest economy in the world in terms of GDP, representing a quarter share of the global economy per the latest World Bank figures.

Considering this, the need of the hour is to choose stocks prudently, avoiding those that carry high debt loads. So the crux of a safe investment lies in identifying low leverage stocks.

And here comes the importance of leverage ratios, which have been constructed historically to safeguard investors from becoming victims of debt trap. 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 indicates improved solvency for a company.

As we have reached the end of Q1, the growth picture seems to be improving compared to what we saw in the year-ago quarter. Naturally, investors must be gearing up to pour money in stocks exhibiting solid earnings growth.

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 might not be a wise move.

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.

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.

Excluding stocks that have a negative or a zero debt-to-equity ratio, here are five of the 64 stocks that made it through the screen.

Louisiana-Pacific Corporation LPX: The company manufactures building materials and engineered wood products in the United States, Canada, Chile and Brazil. It pulled off an average positive earnings surprise of 5.18% in the trailing four quarters and sports a Zacks Rank #1.

ManpowerGroup MAN: It is a global leader in the employment services industry. The company carries a Zacks Rank #2 and has delivered an average positive earnings surprise of 2.72% in the trailing four quarters.

Kulicke and Soffa Industries, Inc. KLIC: It is a leading provider of semiconductor packaging and electronic assembly solutions, supporting the global automotive, consumer, communications, computing and industrial segments. The company pulled off an average positive earnings surprise of 49.14% in the trailing four quarters and sports a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.

Curtiss-Wright Corporation CW: It is an innovative engineering company that provides high-tech, critical function products, systems and services to the commercial, industrial, defense and power markets. The company sports a Zacks Rank #1 and pulled off an average positive earnings surprise of 15.06% in the trailing four quarters.

Huntington Ingalls Industries HII: It designs, manufactures and maintains nuclear and non-nuclear ships for the U.S. Navy and provides after-market services for military ships around the globe. The company carries a Zacks Rank #2 and delivered an average positive earnings surprise of 3.85% in the trailing four quarters.

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Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

Disclosure: Performance information for Zacks’ portfolios and strategies are available at: https://www.zacks.com/performance.

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Kulicke and Soffa Industries, Inc. (KLIC) : Free Stock Analysis Report
 
Huntington Ingalls Industries, Inc. (HII) : Free Stock Analysis Report
 
Curtiss-Wright Corporation (CW) : Free Stock Analysis Report
 
Louisiana-Pacific Corporation (LPX) : Free Stock Analysis Report
 
ManpowerGroup (MAN) : Free Stock Analysis Report
 
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