4 Stocks That Stand Out on Attractive Interest Coverage Ratio

We often judge a company based on its sales and earnings. These metrics, however, 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. However, 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.

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 the profitability of a company 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.

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 a period of time.

Sterling Infrastructure, Inc. STRL, H&R Block, Inc. HRB, Leidos Holdings, Inc. LDOS and Stride, Inc. LRN boast an impressive interest coverage ratio.

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 eight 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. Sterling Infrastructure has a trailing four-quarter earnings surprise of 17.4%, on average.

The Zacks Consensus Estimate for Sterling Infrastructure's current financial year sales and EPS suggests growth of 9.7% and 26.6%, respectively, from a year ago. The stock has surged 38.1% in the past year.

H&R Block, which specializes in assisted income tax return preparation and DIY tax return services and products, sports a Zacks Rank #1 and has a VGM Score of B. HRB has a trailing four-quarter earnings surprise of 10.8%, on average.

The Zacks Consensus Estimate for H&R Block's current financial year sales and EPS suggests growth of 3% and 15.2%, respectively, from the year-ago period. The stock has rallied 62.4% in the past year.

Leidos Holdings, which provides services and solutions in the defense, intelligence, civil and health markets in the United States and internationally, has a VGM Score of A and carries a Zacks Rank #2.

The Zacks Consensus Estimate for Leidos Holdings' current financial year sales and EPS suggests growth of 5.4% and 22.6%, respectively, from a year ago. Leidos Holdings has a trailing four-quarter earnings surprise of 23.5%, on average. The stock has surged 62.7% in the past year.

Stride, a technology-based education company, carries a Zacks Rank #2 and has a VGM Score of A. LRN delivered an earnings surprise of 40.3% in the last reported quarter.

The Zacks Consensus Estimate for Stride's current financial year sales and EPS suggests growth of 6.3% and 7.7%, respectively, from the year-ago period. The stock has soared 87.3% in the past year.

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.

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