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One of the important keys to successful investing is the proper identification of overpriced stocks and correctly priced ones. However, in reality, the overpriced toxic stocks and the fairly priced stocks are intermingled in the market place in such a way that it becomes extremely difficult to distinguish them. Investors who can figure out the toxic stocks and abandon them at the right time are likely to gain.

Generally, toxic stocks are susceptible to external shocks and are loaded with huge debts. Also, sometimes, the price of the toxic stocks is unjustifiably inflated. The irrationally high price of the toxic stocks is only temporary as the intrinsic value of these stocks is lower than the current bloated price.

The inflated 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 a very long period of time, you are sure to see huge erosion in your wealth.

On the other hand, if you can pinpoint 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, identifying toxic stocks and throwing them away at the right time is the key to protect your portfolio from big losses or make profits by short selling them.

Screening Criteria

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 19 toxic stocks that showed up on the screen:

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 quarter estimates widened from a loss of a penny per share to a loss of 2 cents. The company has a Zacks Rank #3. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Live Nation Entertainment, Inc. (LYV - Free Report) is a Beverly Hills, CA-based live entertainment company. Over the past 30 days, its second-quarter 2017 estimates remained unchanged at 17 cents a share. The stock currently has a Zacks Rank #3.

Salesforce.com, inc. (CRM - Free Report) is a San Francisco, CA-based computer software industry firm. Over the past one month period, its second quarter earnings estimate has declined 18.2% to 9 cents a share. Currently, the company carries a Zacks Rank #3.

Boston, MA-based, Vertex Pharmaceuticals Incorporated (VRTX - Free Report) is a biotechnology company. Over the past one-month period, current quarter estimates remained unchanged at 5 cents per share. The stock currently has a Zacks Rank #3.

NeoGenomics, Inc. (NEO - Free Report) is a Fort Myers, FL-based company belonging to the biomedical and genetics industry. Over the past one-month period, current quarter estimates remained unchanged at 2 cents per share. The stock currently has 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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