7 Stocks To Buy With Impressive Interest Coverage Ratio

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 guarantee returns. A critical analysis of the company’s financial background is always required for a better investment decision. 

A company’s fundamentals should be sound enough to meet its financial obligations. This can be judged through coverage ratios — the higher these are the more efficient an enterprise will be in meeting its financial obligations. The focus of this article is on Interest Coverage which is one such ratio.

Why Interest Coverage Ratio?

Interest Coverage Ratio is used to determine how effectively a company can pay the interest charges on its debt.

Debt, which is very important for most of the companies to finance operations, comes at a cost called interest. Interest expense has a direct bearing on the profitability of a company and the company’s creditworthiness depends on how effectively it meets its interest obligations. Therefore, Interest Coverage Ratio is one of the important criteria to factor in before making any investment decision.

Formula: Interest Coverage Ratio = Earnings before Interest & Taxes (EBIT) divided by Interest Expense. Interest Coverage Ratio suggests the number of times the 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 in 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.

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.

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