Low-Leverage, High-Quality Stocks

In this week's screen, we go topsy-turvy and look for the opposite of what we looked for last week

This week, we'll take a page from Seinfeld sidekick George Costanza and "do the opposite." (For those of you who don't remember, a famous episode of the sitcom detailed George's inexplicable success in a number of endeavors when he decided to do the exact opposite of what he would normally do in a given situation.)

In this case, we're going to turn around the criteria we used in last week's screen, when we hunted for highly leveraged stocks with unfavorable profit trends and low quality marks from Standard & Poor's (see BusinessWeek.com, 7/6/07, "Stocks: 11 Leveraged Laggards").

We developed that screen amid rising concerns in the stock market about high degrees of corporate leverage and poor earnings prospects for many companies. So this week we decided to take a walk on the low-leverage, high-quality side of the Street.

Rewarding Growth and Stability

Here's how we turned last week's screen on its head. Last time, we looked for those companies with gross profit margin in the lowest 20% of the U.S. equity universe. This time, we looked for names in the top 20%.

The same thing with our second criterion. In our last screen, we searched for those companies with a debt-to-capital ratio in the highest 20% of the U.S. equity universe, signaling that they carry a far greater degree of leverage than the broader market. This time we looked for those companies in the lowest 20%.

Our final 180-degree turn was to look for those stocks with an S&P Quality Ranking, which measures growth and stability of earnings and dividends over a 10-year period, of A or better. In the previous screen, we included underachievers with a ranking of C or worse.

Looking Beyond Subprime Loans

We did one thing exactly the same as last time: To avoid speculative issues, we only included those names with a stock price above $5 per share and a market capitalization above $1 billion.

The topsy-turvy screen pulled out seven names. One thing that jumps out is that there are two big investment banks on the list: Bear Stearns and Lehman Brothers. While companies in this group have garnered their share of headlines amid the recent problems with subprime loans, they have historically had strong capital structures and consistent earnings and dividend records.

Company S&P Quality Rank
Bear Stearns (BSC) A+
Factset Research Systems (FDS) A
Lehman Brothers Holdings (LEH) A
Linear Technology (LLTC) A
Paychex (PAYX) A+
Strayer Education (STRA) A
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