In corporate finance, leverage is a well-known concept that refers to the practice of borrowing capital by companies to run their operations smoothly and grow similarly. In particular, these loans can be made either by equity financing or by debt financing.

Empirically, it has been observed that the majority of companies prefer debt financing over equity to obtain such funds. This is because debt is cheaper than equity, especially in times of low interest rates. In addition, in the case of equity financing, a shareholder not only becomes a partial owner of a business, but also has a right to a direct right to its future profits. So, most companies try to avoid equity financing.

However, debt financing has its own drawbacks. In particular, exorbitant debt financing can hurt a company’s financial position and lead to bankruptcy in the worst case. Therefore, the level of indebtedness of a company is an important point to take into account when making an investment decision.

If a stock is heavily leveraged, which means it has considerably high debt, it is wise to avoid it.

Given the aforementioned discussion, a low-leverage stock should find its place in an investor’s portfolio. To measure this leverage, several ratios have been used historically. The debt ratio is one of the most common among these ratios.

Debt / Equity Analysis

Debt ratio = Total liabilities / Equity

This measure is a liquidity ratio that indicates the amount of financial risk borne by a business. A company with a lower debt ratio shows better creditworthiness for a company.

With the third quarter earnings season knocking upon us, investors should watch out for stocks that have shown strong earnings growth in the recent past. But if a stock has a high debt ratio, during an economic downturn, its so-called image of booming earnings could turn into a nightmare.

The winning strategy

Considering the aforementioned factors, it is prudent to choose stocks with a low leverage ratio to ensure stable returns.

However, an investment strategy based solely on the debt ratio might not achieve the desired result. To choose stocks that have the potential to provide you with stable returns, we have broadened our selection criteria to include other factors.

Here are the other parameters:

Debt / Equity Below Median of Industry X: Equities less indebted than their sector counterparts.

Current price greater than or equal to 10: Stocks should trade at a minimum of $ 10 or more.

Average volume over 20 days greater than or equal to 50,000: A substantial trading volume ensures that the stock is easily tradable.

Percentage change in F (0) / F (-1) EPS greater than the industry median X: Earnings growth adds to optimism, leading to an appreciation in the price of a stock.

VGM score of A or B: Our research shows that stocks with a VGM score of A or B, when combined with a Zacks Rank # 1 (Strong Buy) or 2 (Buy), offer the best upside potential.

Estimated EPS growth over one year F (1) / F (0) greater than 5: This shows earnings growth expectations

Zacks Rank # 1 or 2: Regardless of market conditions, stocks with a Zacks # 1 (strong buy) or 2 (buy) ranking have a proven track record of success.

Excluding stocks that have a negative or zero debt ratio, here are five of the 25 stocks that made it through the screen.

ScanSource, Inc. (Quick quote SCSCSCSC – Free Report): It serves North America as a value-added distributor of specialized technologies, including automatic identification and point-of-sale products, and business telephony products. The company has generated a surprise of 27.90% on average over the past four quarters and currently has a Zacks # 1 ranking.

Jacobs Engineering Group Inc. (J Quick quoteJ – Free Report): It is a leading provider of professional, technical and construction services to industrial, commercial and government clients. The company currently holds a Zacks Rank # 2 and has achieved a surprise profit of 17.54% over the past four quarters, on average.

CBIZ, Inc. (Quick quote CBZCBZ – Free Report): It provides professional business services that help clients better manage their finances and employees. The company achieved a surprise profit of 43.44% on average over the four quarters and has a Zacks ranking of 2. You can see The full list of today’s Zacks # 1 Rank stocks here.

Primerica, Inc. (Quick quote PRIPRI – Free Report): It provides financial products and services. Currently, the company has a Zacks rank of 2. It has achieved a surprise profit of 7.55% on average over the four quarters.

AdvanSix Inc. (ASIX quick quoteAT SIX – Free Report): It is a producer and supplier of Nylon 6 materials. The company currently sports a No.1 Zacks ranking and achieved a surprise profit of 50.74% on average over the four quarters.

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

Disclosure: Information on the performance of Zacks’ portfolios and strategies can be found at: https://www.zacks.com/performance.