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The proper identification of rightly priced stocks and overpriced stocks makes investing an easy task. However, in a complicated marketplace, the correctly priced stocks and their steeply priced counterparts are intertwined in such a way that making a distinction is tough. Nevertheless, figuring out the bloated toxic stocks on a regular basis and getting rid of them at the right time is one of the secrets to a winning investment strategy.

Generally, toxic companies are characterized by huge debt burdens and are susceptible to external shocks. Unjustifiably 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 into loss for investors over time.

Overpricing of the toxic stocks can be attributed to either an irrational exuberance associated with them or some serious fundamental lacunae. If you own such overblown stocks for a long period of time, you are bound to see considerable erosion of wealth.

However, if you can accurately identify 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 spotting stocks with growth potential, figuring out toxic stocks and abandoning them at the right time is the key 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 the 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 -2: 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.

Here are five of the 10 toxic stocks that showed up on the screen:

Houston, TX-based Cabot Oil & Gas Corporation (COG - Free Report) is an oil and gas company engaged in the exploration, development, acquisition and exploitation of oil and gas properties in the U.S. Over the past one-month period, its quarterly estimate has declined 40% to 3 cents. The stock currently has a Zacks Rank #3.

Boulder, CO-based Zayo Group Holdings, Inc. (ZAYO - Free Report) is a provider of bandwidth infrastructure solutions to the communications industry in the U.S., Canada, and Europe. Over the last 30 days, quarterly estimates remained stable at 5 cents a share. The company has a Zacks Rank #3. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Etsy, Inc. (ETSY - Free Report) is a Brooklyn, NY-based Internet services company, which operates a marketplace to make, sell, and buy goods online and offline worldwide. Over the last 30 days, quarterly estimates remained stable at 1 cent a share. The company has a Zacks Rank #3.

Live Nation Entertainment, Inc. (LYV - Free Report) is a Beverly Hills, CA-based live entertainment company. Over the past one-month period, the quarterly estimate has declined 2% to 48 cents. The stock currently has a Zacks Rank #3.

Boston, MA-based, Vertex Pharmaceuticals Incorporated (VRTX - Free Report) is a bio-technology company. Over the past one-month period, the current quarter estimate has moved down from 9 cents a share to a no loss, no gain situation. The stock currently has a Zacks Rank #4 (Sell).

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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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