4 Stocks Leading in Interest Coverage as Wall Street Eyes Rate Cuts

The U.S. equity markets closed higher yesterday as optimism about potential monetary easing outweighed concerns about softening labor data. The S&P 500 advanced 0.83% to finish at 6,502.08. The Nasdaq Composite added 0.98% to end at 21,707.69, while the Dow Jones Industrial Average gained 350.06 points, or 0.77%, to settle at 45,621.29.

Investors digested new economic data showing a slowdown in job creation. According to the ADP private payrolls report, only 54,000 jobs were added in August, falling short of expectations and significantly below the revised 106,000 jobs recorded in July. Despite the softer employment numbers, stocks rose as traders viewed the data as supporting a potential rate cut by the Federal Reserve.

Shift Focus to Financially Resilient Stocks

In such a macroeconomic environment, it becomes increasingly important to focus on companies with strong financial fundamentals. We often judge a company based on its sales and earnings. However, these metrics may not be sufficient on their own. A stock might get a boost if these figures rise year over year or surpass estimates in a particular quarter, offering a lucrative opportunity for short-term investors to cash in. Relying solely on sales and earnings numbers may not yield the desired long-term returns. For those seeking sustainable investment growth, a deeper dive into the company’s financial health and stability is essential.

A critical analysis of a company’s financial background is a prerequisite for an informed investment decision. Coverage ratios, which assess whether a company is robust enough to meet its financial obligations, play a crucial role in this analysis. A higher ratio generally indicates a stronger financial position. This article focuses on the Interest Coverage Ratio, a key indicator used to evaluate a company's ability to pay interest on its debt, ensuring that the company is not over-leveraged and can comfortably meet its interest obligations from its operating earnings.

Interest Coverage Ratio = Earnings before Interest & Taxes (EBIT) divided by Interest Expense. 

Vertiv Holdings Co VRT, Stride, Inc. LRN, Ralph Lauren Corporation RL and The Cheesecake Factory Incorporated CAKE have impressive interest coverage ratios.

Why Interest Coverage Ratio?

The interest coverage ratio is used to determine how effectively a company can pay the interest charges 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 a company's profitability, and its creditworthiness depends on how effectively it meets 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 the interest could be paid from earnings and 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 hardships. One should also track the company’s past performance to determine whether the interest coverage ratio has improved or worsened over time.

The Winning 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 18 stocks that qualified the screening:

Vertiv Holdings, a global leader in critical digital infrastructure, carries a Zacks Rank #2. The company has a trailing four-quarter earnings surprise of 10.7%, on average. You can see the complete list of today’s Zacks #1 Rank stocks here.

The Zacks Consensus Estimate for Vertiv Holdings’ current financial-year sales and EPS implies growth of 24.5% and 34%, respectively, from the year-ago period. Vertiv Holdings has a VGM Score of B. Shares of Vertiv Holdings have advanced 75.2% in the past year.

Stride, a technology-based education company, carries a Zacks Rank #2 and has a VGM Score of A. LRN has a trailing four-quarter earnings surprise of 98.7%, on average. 

The Zacks Consensus Estimate for Stride’s current financial-year sales and EPS indicates growth of 11% and 5.9%, respectively, from the year-ago period. The stock has soared 104.1% in the past year. 

Ralph Lauren, a global leader in the design, marketing and distribution of luxury lifestyle products, carries a Zacks Rank #2 and has a VGM Score of B. The company has a trailing four-quarter earnings surprise of 8.5%, on average. 

The Zacks Consensus Estimate for Ralph Lauren’s current financial-year sales and EPS calls for growth of 6% and 19.8%, respectively, from the year-ago period. The stock has advanced 85.6% in the past year. 

The Cheesecake Factory, a leader in experiential dining, carries a Zacks Rank #2 and has a VGM Score of B. The company has a trailing four-quarter earnings surprise of 15.2%, on average. 

The Zacks Consensus Estimate for Cheesecake Factory’s current financial-year sales and EPS suggests growth of 5.1% and 9.6%, respectively, from the year-ago period. The stock has advanced 63.1% in the past year. 

You can get the rest of the stocks on this list by signing up now for your 2-week free trial to the Research Wizard and start using this screen in your own trading. Further, you can also create your own strategies and backtest them first before taking the investment plunge.

The Research Wizard is a great place to begin. It's easy to use. Everything is in plain language. And it's very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open up the Research Wizard, plug your finds in, and see what gems come out.

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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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This article originally published on Zacks Investment Research (zacks.com).

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