You can simply come to a decision to buy or sell a particular stock by looking at its sales and profit numbers. But such a strategy does not always guarantee superior returns. A critical analysis of the financial context of the company is always necessary for a better investment decision.
The fundamentals of a business must be strong enough to meet its financial obligations. This can be assessed using coverage ratios – the higher they are, the more efficient a business will be in meeting its financial obligations. Here we have discussed such a ratio called Interest Coverage Ratio.
Interest coverage ratio = Earnings before interest and taxes (EBIT) divided by interest expense.
Why an interest coverage ratio?
The interest coverage ratio is used to determine how efficiently a business can pay the interest charged on its debt.
Debt, which is crucial for most businesses to finance their operations, has a cost called interest. Interest expense has a direct impact on a company’s profits. The solvency of the enterprise depends on the efficiency with which it meets its interest obligations. Therefore, the interest coverage rate is one of the important criteria to consider before making any investment decision.
The interest coverage ratio suggests the number of times interest could be paid from profits and also assesses the margin of safety that a company has to pay interest.
An interest coverage ratio of less than 1.0 implies that the company is unable to meet its interest obligations and could default on its debt repayments. A business capable of generating profits well in excess of its interest expense can endure financial hardship. Certainly, one should also follow the past performance of the company to determine whether the interest coverage ratio has improved or worsened over a period of time.
What is the strategy?
In addition to having an interest coverage ratio above the industry average, the addition of a favorable Zacks ranking and a VGM score of A or B to your search criteria should lead to better results.
Interest coverage ratio greater than the X-Industry median
Price greater than or equal to 5: The stocks should all trade at a minimum of $ 5 or more.
Historical 5-year EPS growth (%) above industry median X: Stocks that have a history of strong EPS growth.
Projected EPS growth (%) above industry X median: This is the expected growth in BPA over the next three to five years. This shows that the stock has the potential for short-term earnings growth.
Average volume over 20 days greater than 100,000: A substantial trading volume ensures that the stock is easily tradable.
Rank of Zacks less than or equal to 2: Zacks Rank # 1 (Strong Buy) or 2 (Buy) stocks are known to outperform regardless of the market environment.
VGM score less than or equal to B: Our research shows that stocks with a VGM score of A or B when combined with a Zacks # 1 or 2 rank offer the best upside potential.
Here are five of the 15 actions that qualified the screening:
O’Reilly Automotive, Inc. (ORLY – Free Report), one of the largest specialty retailers of automotive aftermarket parts, tools, supplies, equipment and accessories, has a Zacks Rank # 2 and a VGM Score of A. Growth rate Expected three to five year EPS is currently 14.4%. . You can see The full list of today’s Zacks # 1 Rank stocks here.
CBRE Group, Inc. (CBRE – Free Report), a commercial and investment real estate services company, has a Zacks Rank # 2 and VGM Score of A. The expected three to five year EPS growth rate is 11%.
Lithia Motors, Inc. (BOY – Free Report), which offers new and used vehicles as well as vehicle finance services, has an VGM score of A and an expected EPS growth rate of 20.9% over 3-5 years. The stock carries a Zacks Rank # 2.
The inter-public group of companies, Inc. (IPG – Free Report), which provides global advertising and marketing services, has a Zacks Rank # 2 and VGM score of B. The company has an expected BPA growth rate of 12.6% for three to five years.
Aflac Incorporated (AFL – Free Report), which provides additional health and life insurance products, has an VGM score of B and an expected EPS growth rate of 5% over 3-5 years. The stock carries a Zacks Rank # 2.
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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.