Distinguishing between overpriced stocks and fairly priced stocks is the key to successful investing. But the task is not easy as the correctly priced and the overvalued stocks are mingled in a very deceptive way in the marketplace.
However, investors who can pinpoint the overhyped toxic stocks and discard them at the right time are the ones who are poised to benefit.
Usually toxic companies are vulnerable to external shocks. These companies are burdened with huge debts too.
Also, unjustifiably high price of the toxic stocks is short-lived as their current price exceeds their inherent value. Quite naturally, these stocks are bound to result in loss for investors over time.
Higher price of the toxic stocks can be attributed to either an irrational exuberance associated with them or some serious fundamental lacuna. If you own such stocks for long, you are likely to see a big loss in your wealth.
If you can, however, precisely spot the 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 figuring out stocks with growth potential, identifying toxic stocks and discarding them at the right time is the key to shield 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. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Here are five of the 19 toxic stocks that showed up on the screen:
Live Nation Entertainment, Inc. (LYV) is a Beverly Hills, CA-based live entertainment company. Over the past 60 days, its 2016 loss estimate widened from a loss of 13 cents to a loss of 17 cents. The stock currently has a Zacks Rank #3.
The Woodlands, TX-based Conns, Inc. (CONN) is a specialty retailer, which currently operates retail locations in Texas and Louisiana. Over the last 60 days, its 2017 loss estimate has widened from a loss of 41 cents to a loss of 54 cents. Conns carries a Zacks Rank #3.
ConocoPhillips (COP) is a Houston, TX-based major global exploration and production company with operations and activities in 21 countries that include the U.S., Canada, the U.K./Norway, China, Australia, offshore Timor-Leste, Indonesia, Libya, Nigeria, Algeria, Russia and Qatar. Over the past 60 days, its 2016 loss estimate has widened from a loss of $2.73 per share to a loss of $2.78. The company has a Zacks Rank #3.
Etsy Inc (ETSY) 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 60 days, its 2016 loss estimate has widened from a loss of 6 cents per share to a loss of 7 cents. The company has a Zacks Rank #3.
Wilmington, DE-based Incyte Corporation (INCY) is a drug discovery company. Over the last 60 days, its 2016 estimate declined 1.6% to 62 cents per share. Conns carries 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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