4 Toxic Stocks To Dump Or Play Short To Reap Profits
Zacks Investment Research | Mar 17, 2020 10:42PM ET
Accuracy in distinguishing overpriced stocks from the fairly priced ones leads to profitable investing. In a complicated market place, the overpriced stocks and the correctly priced ones are intermixed in such a way that differentiating between the two is a tough task. Figuring out bloated toxic stocks on a consistent basis and discarding them at the right time is the key to successful investing.
Usually, toxic companies are characterized by a high debt burden and are vulnerable to external shocks. The hype associated with the irrationally high-priced toxic stocks is usually short-lived as their intrinsic value falls short of their current price. Elevated price levels of these stocks can be due to either an irrational exuberance associated with them or some serious fundamental lacunae. If you own such overhyped stocks for a long period of time, you are bound to see huge loss of wealth.
However, if you can correctly pick 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 picking stocks with huge growth potential, figuring out toxic stocks and abandoning them at the right time is the key to shield your portfolio from big losses. You can make profits by short selling them.
Screening Criteria
Here is a winning strategy that will help you 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 overvalued.
% Change in F (1) and F (2) Estimate (12 Weeks) less than 0: 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 the Buy-rated stocks that generally outperform the market. You can see Zacks Investment Research
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