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These 4 Toxic Stocks Could Endanger Your Portfolio

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The secret of successful investing lies in the proper identification of overpriced stocks and reasonably priced stocks. In a complex market place, overblown stocks and the correctly priced ones are intertwined in such a way that it is not easy to distinguish between them. However, spotting the bloated toxic stocks on a regular basis and abandoning them at the right time is one of the secrets to a winning investment strategy.

Usually, toxic companies are characterized by huge debt burden and are vulnerable to external shocks. Irrationally high price of the toxic stocks is short-lived as their current price is higher than their intrinsic value and these are bound to result in loss for investors over time.

Overpricing of the toxic stocks can be ascribed to either an irrational exuberance surrounding them or some serious fundamental drawbacks. If you own such bubble stocks for an inordinate period of time, you are bound to see massive erosion of wealth.

However, if you are a smart investor and can precisely spot 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 pinpointing stocks with growth potential, identifying toxic stocks and discarding them at the right time is crucial to shield your portfolio from big losses or make profits by short selling them.

Screening Criteria

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

Most recent Debt/Equity Ratio greater than the median industry average: High debt/equity ratio implies increased 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 fiscal year and the next over 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 four of the 21 toxic stocks that showed up on the screen.

Carrols Restaurant Group, Inc. (TAST - Free Report) : This Zacks Rank #5 (Strong Sell) company is the largest BURGER KING franchisee in the United States, with more than 800 restaurants. Since the paradigm shift occurred, restaurant stocks have been hit hard amid their closure, partial opening and restrictions related to the coronavirus outbreak. The Retail – Restaurants industry is currently in the bottom 13% of the Zacks Industry Rank, validating the headwinds surrounding the space. The Zacks Consensus Estimate for Carrols’ fiscal 2021 earnings has been revised 25% downward over the past 30 days.

Nuance Communications, Inc. (NUAN - Free Report) Domiciled in Massachusetts, Nuance provides conversational and cognitive artificial intelligence innovations. Declining revenues and earnings are keeping investors, who are contemplating 2021 investing strategy in the software space, on tenterhooks. Prospects pertaining to emerging cloud businesses and the underpenetrated healthcare transcription market amid telemedicine wave are eclipsed by coronavirus-induced delay in payments and renewals related to HIM Transcription and EHR businesses. The consensus mark for fiscal 2021 earnings per share has moved 13.8% south over the past 60 days. The firm currently carries a Zacks Rank #5.

Hexcel Corporation (HXL - Free Report) : This Zacks Rank #4 (Sell) company manufactures and distributes lightweight, high-performance structural materials for use in Commercial Aerospace, Space & Defense, as well as Industrial markets. Bulk of Hexcel’s revenues come from selling composite materials used in the manufacture of commercial aircraft. With demand for domestic air travel dropping precipitously and international travel suspended altogether, orders for new aircraft are on a decline. The Zacks Consensus Estimate for fiscal 2021 earnings has been revised 35% downward over the past 60 days.

Melco Resorts & Entertainment Limited (MLCO - Free Report) : This Zacks Rank #3 company is a developer, owner and operator of casino gaming, as well as entertainment casino resort facilities, primarily in Asia. The firm’s operations have been heavily impacted by the deadly coronavirus. The Zacks Consensus Estimate for 2020 is pegged at a loss of $2.83 per share, indicating a year-on-year deterioration of more than 401%. Traffic is still very low due to safety protocols and fears related to the pandemic. The consensus mark for 2021 earnings has declined 66.6% over the past 60 days.

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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