The ability to differentiate overhyped stocks from the fairly priced ones makes the investing foolproof. But in the complex market place, correctly priced stocks and over-bubble stocks are mingled in such a way that making a distinction between them becomes very difficult. Nevertheless, precisely pinpointing bloated toxic stocks on a regular basis and abandoning them at the right time is one of the secrets to a winning investment strategy.

Toxic companies are usually vulnerable to external shocks and are characterized by high debt loads. The hype surrounding irrationally high-priced toxic stocks is usually short-lived as their current price exceeds the intrinsic value. These toxic stocks are bound to result in loss for investors over time.

Higher prices of toxic stocks can be ascribed to either an irrational exuberance associated with them or some serious fundamental drawbacks. If you own such bloated stocks for a long period of time, you are bound to see huge erosion of wealth.

However, if you can correctly pick such toxic stocks, you may gain by resorting to an investing strategy called short selling. This strategy allows you to sell a stock first and then buy it when the price falls.

While short selling excels in bear markets, it typically loses money in bull markets.

So, just like identifying stocks with growth potential, pinpointing toxic stocks and discarding them at the right time is the key to guard your portfolio from big losses or make profits by short selling them.

Screening Criteria

Here is a winning strategy that will help you identify overhyped toxic stocks:

Most recent Debt/Equity Ratio greater than the median industry average: High debt/equity ratio implies high leverage. High leverage indicates a huge level of repayment that the company has to make in connection with the debt amount.

P/E using 12-month forward EPS estimate greater than 50: A very high forward P/E implies that a stock is highly overvalued.

% Change in F (1) and F (2) Estimate (12 Weeks) less than -5: Negative EPS estimate revision for this and the next fiscal year during the past 12 weeks points to analysts’ pessimism.

Zacks Rank more than or equal to #3 (Hold): We have not considered Buy-rated stocks that generally outperform the market. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Here are five of the 12 toxic stocks that showed up on the screen:

Pittsburgh, PA-based Allegheny Technologies Inc. (ATI Quick QuoteATI - Free Report) is an industrial goods company which is engaged in the production and selling of specialty materials and components worldwide. Over the past one-month period, the current quarter estimate has deteriorated from a profit of 3 cents a share to a loss of 9 cents. The stock currently has a Zacks Rank #3.

salesforce.com, inc. (CRM Quick QuoteCRM - Free Report) is a San Francisco, CA-based computer software industry firm. Over the past one-month period, its current quarter earnings estimate has remained unchanged at 6 cents. Currently, the company carries a Zacks Rank #3.

Pittsburgh, PA-based United States Steel Corp. (X Quick QuoteX - Free Report) is engaged in the manufacture and selling of a variety of steel mill products, coke and taconite pellets. Over the past one-month period, its current quarter earnings estimate has drastically declined from 73 cents a share to 7 cents. Currently, the company carries a Zacks Rank #3.

Boston, MA-based, Vertex Pharmaceuticals Incorporated (VRTX Quick QuoteVRTX - Free Report) is a bio-technology company. Over the past one-month period, the current quarter estimate has moved down from earnings of 6 cents a share to a no loss, no gain situation. The stock currently has a Zacks Rank #3.

Oklahoma City, OK-based Continental Resources, Inc. is engaged in the exploration, development and production of crude oil and natural gas properties in the north, south, and east regions of the U.S. Over the past one-month period, its current quarter estimate has remained unchanged at a loss of 10 cents. Currently, the company carries a Zacks Rank #3.

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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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