Investing success hinges upon precise identification of overpriced stocks and fairly priced ones. However, the over-hyped toxic stocks and the correctly priced stocks are mingled in the marketplace in such a way that it becomes very tough to differentiate between them. Investors who can pinpoint the toxic stocks and discard them at the right time are likely to gain.
Generally, toxic stocks are vulnerable to external shocks and are loaded with high levels of debt. Also, price of the toxic stocks is irrationally high. The unjustifiably high price of the toxic stocks is only short-lived as the intrinsic value of these stocks is lower than the current bloated price.
The inflated price of the toxic stocks can be ascribed to either an irrational exuberance associated with them or some serious fundamental lacunae in the stock. If you own such stocks for a long period of time, you are likely to witness huge erosion in your wealth.
On the other hand, if you can figure out the toxic stocks correctly, 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, picking up toxic stocks and abandoning them at the right time is the key to protect your portfolio from big losses. Profits can be made 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:
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, current quarter estimates declined 11.1% to 24 cents. The stock currently has a Zacks Rank #3. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Oklahoma City, OK-based Continental Resources, Inc. (CLR - Free Report) is a crude-oil concentrated, independent oil and natural gas exploration and production company. Over the past one-month period, current quarter estimates declined from 5 cents to a break-even. The stock currently has a Zacks Rank #3.
Halcon Resources Corporation (HK - Free Report) is a Houston, TX-based energy company engaged in the acquisition, exploration and development of onshore oil and natural gas properties in the U.S. Over the past one-month period, current quarter estimates declined from 8 cents to a penny. The stock currently has a Zacks Rank #4 (Sell).
Houston, TX-based Apache Corporation (APA - Free Report) is engaged in exploration, development and production of natural gas, crude oil and natural gas liquids. Over the past one-month period, current quarter estimates declined from 31 cents to 10 cents per share. The stock currently has a Zacks Rank #5 (Strong Sell).
Seattle, WA-based Zillow Group, Inc. (ZG - Free Report) is engaged in providing real estate and home-related brands on the web and mobile. Over the past one-month period, current quarter estimates have widened from a loss of 14 cents to a loss of 15 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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