Given the current economic scenario, investors should gauge the changing market dynamics and accordingly chalk out a sturdy investment strategy. Well, you can simply arrive at a decision to buy or sell a particular stock by looking at its sales and earnings numbers. But such a strategy does not always warrant superior returns when the market is facing myriad issues. A critical analysis of the company’s financial background is always required for a better investment decision.
Well, a company should be sound enough to meet its financial obligations. This can be judged with coverage ratios — the higher these are the more efficient an enterprise will be in meeting its financial obligations. Here we have discussed one such ratio called the interest coverage ratio.
Interest Coverage Ratio = Earnings before Interest & Taxes (EBIT) divided by Interest Expense.
Why Interest Coverage Ratio?
Interest coverage ratio is used to determine how effectively a company can pay the interest charged on its debt.
Debt, which is crucial for most companies to finance operations, comes at a cost called interest. Interest expense has a direct bearing on the profits of a company. The company’s creditworthiness depends on how effectively it meets its interest obligations. Therefore, the interest coverage ratio is one of the important criteria to factor in before making any investment decision.
The interest coverage ratio suggests the number of times interest could be paid from earnings and also gauges the margin of safety a firm carries for paying interest.
An interest coverage ratio lower than 1.0 implies that the company is unable to fulfill its interest obligations and could default on repaying debt. A company that is capable of generating earnings well above its interest expense can withstand financial hardship. Definitely, one should also track the company’s past performance to determine whether the interest coverage ratio has improved or worsened over a period of time.
What’s the Strategy?
Apart from having an interest coverage ratio that is more than the industry average, adding a favorable Zacks Rank and a VGM Score of A or B to your search criteria should lead to better results.
Interest coverage ratio greater than X-Industry Median
Price greater than or equal to 5: The stocks must all be trading at a minimum of $5 or higher.
5-Year Historical EPS Growth (%) greater than X-Industry Median: Stocks that have a strong EPS growth history.
Projected EPS Growth (%) greater than X-Industry Median: This is the projected EPS growth over the next three to five years. This shows that the stock has near-term earnings growth potential.
Average 20-Day Volume greater than 100,000: A substantial trading volume ensures that the stock is easily tradable.
Zacks Rank less than or equal to 2: Zacks Rank #1 (Strong Buy) or 2 (Buy) stocks are known to outperform irrespective of the market environment.
VGM Score of less than or equal to B: Our research shows that stocks with a VGM Score of A or B when combined with a Zacks Rank #1 or 2 offer the best upside potential.
Here are four of the 10 stocks that qualified the screening:
Sterling Infrastructure, which is engaged in e-infrastructure, transportation, and building solutions, sports a Zacks Rank #1 and has a VGM Score of B. The expected EPS growth rate for three-five years is 20%.
The Zacks Consensus Estimate for Sterling Infrastructure’s current financial year sales and EPS suggests growth of 3.8% and 29.4%, respectively, from the year-ago period. Sterling Infrastructure has a trailing four-quarter earnings surprise of 14.9%, on average. The stock has skyrocketed 218.8% in the past year.
Sprouts Farmers, which offers fresh, natural, and organic food products in the United States, carries a Zacks Rank #2 and has a VGM Score of A. Its expected EPS growth rate for three to five years is 9.3%.
The Zacks Consensus Estimate for Sprouts Farmers’ current financial year sales and EPS suggests growth of 5.7% and 14.6%, respectively, from the year-ago period. SFM has a trailing four-quarter earnings surprise of 14.3%, on average. The stock has rallied 39.8% in the past year.
Molina Healthcare, which provides managed healthcare services under the Medicaid and Medicare programs and through the state insurance marketplaces, carries a Zacks Rank #2 and has a VGM Score of A. The expected EPS growth rate for three to five years is 14.2%.
The Zacks Consensus Estimate for Molina Healthcare’s current financial year sales and EPS suggests growth of 3.4% and 15.3%, respectively, from the year-ago period. Molina Healthcare has a trailing four-quarter earnings surprise of 7.2%, on average. The stock has declined 4.4% in the past year.
McKesson, which provides healthcare services in the United States and internationally, carries a Zacks Rank #2 and has a VGM Score of B. The expected EPS growth rate for three to five years is 10.7%.
The Zacks Consensus Estimate for McKesson’s current financial year sales and EPS suggests growth of 10.9% and 4.2%, respectively, from the year-ago period. McKesson has a trailing four-quarter earnings surprise of 8.1%, on average. The stock has advanced 23.7% in the past year.
McKesson Corporation (MCK): Free Stock Analysis Report
This article originally appeared on Zacks
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