One of the important aspects of successful investing is the accurate identification of overpriced and fairly priced stocks. However, it is not easy to distinguish between overvalued stocks and the correctly priced ones as they are all intermingled in the marketplace. Investors who can identify the toxic stocks and discard them at the right time are more likely to gain.
Usually toxic companies are burdened with huge debts and are vulnerable to external shocks. Also, unreasonably high price of toxic stocks is only short-lived as the intrinsic value of these stocks is lower than the current bloated price.
The high price of the toxic stocks can be due to either an irrational exuberance associated with them or some serious fundamental drawback. If you own such stocks for an inordinate period of time, you are likely to see a big erosion in your wealth.
On the contrary, if you can spot the toxic stocks accurately, 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, figuring out toxic stocks and dumping them at the right time is the key to protect your portfolio from big losses or make profits by short selling them.
Here is a winning strategy that will help you to identify overpriced 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.
Here are five of the 18 toxic stocks that showed up on the screen:
Covanta Holding Corporation (CVA - Free Report) is a Morristown, NJ-based alternative energy company that provides waste and energy services in the U.S. and Canada. Over the past 30 days, its current quarter estimates widened from a loss of 15 cents per share to a loss of 18 cents. 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. It operates a marketplace to make, sell and buy goods online and offline worldwide. Over the last 30 days, its current quarter estimates changed from earnings of a cent per share to break even. The company has a Zacks Rank #3.
PTC Inc. (PTC - Free Report) is a Needham, MA-based software company engaged in developing, marketing and supporting software solutions. Over the past one-month period, the current quarter estimates declined 5.9% to 16 cents. The stock currently has a Zacks Rank #3.
Wilmington, DE-based Incyte Corporation (INCY - Free Report) is a drug discovery company. Over the last 30 days, its current quarter estimates changed from a gain of 53 cents per share to a loss of 74 cents per share. Incyte carries a Zacks Rank #5 (Strong Sell).
Boston, MA-based, Vertex Pharmaceuticals Incorporated (VRTX - Free Report) is a bio-technology company. Over the past one-month period, current quarter estimates moved up from 2 cents per share to 4 cents. The stock currently has a Zacks Rank #5.
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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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