Zacks

Buy These 5 Low Leverage Stocks to Avoid Portfolio Losses

Zacks Equity Research
Updated

Debt financing is nothing new in the world of investment and only a fortunate few can avoid it. Most corporates resort to debt financing to ensure smooth business operations. This is because companies do not have unlimited funds and they need to boost their financial resources from time to time to expand operations.

In fact, given the easy availability and affordability of debt compared to equity, in the majority of matured economies, the debt market is bigger than the equity market in terms of market capitalization. America – the richest economy in the world – is the biggest borrower too.

However, resorting to debt is still considered a taboo as it carries the burden of interest payments.

In this context, it is imperative to note that the debt scenario in the U.S. is quite disturbing at this moment. Huge spending on wars, big tax cuts and stimulating economic programs have all added to the nation’s burden over the years. The Congressional Budget Office estimates that the debt held by the public will rise to 150% of the economy’s GDP in 2047 from 77% currently.

Nevertheless, this should not dissuade investors from investing in stocks as debt has been a part of the U.S. economy since its foundation. What investors need to do is to follow a prudent investment strategy and choose stocks that are burdened with lesser amount of debt.

Herein comes the significance of financial leverage ratio. This ratio measures the extent of financial leverage, or the extent of debt a company bears. Several leverage ratios have been developed historically for this purpose, with debt-to-equity ratio being the most popular among them.

Analyzing Debt-to-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 lower debt-to-equity ratio implies a more financially stable business, thereby making it a more worthy investment opportunity.

As debt-ridden companies are more prone to bankruptcy in times of financial crisis, the very foundation of making safe investment is to avoid high-leverage stocks.

With the market gearing up for second-quarter releases, investors tend to get attracted to stocks exhibiting solid earnings growth, overlooking the debt on their balance sheet. Therefore to avoid huge losses we would urge investors to go for stocks with low debt-to-equity ratio.

The Winning Strategy

Considering the aforementioned discussion, it is imperative for a sensible investor to choose stocks that have a low debt-to-equity ratio.

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