Accurate identification of correctly priced stocks is the key to successful investing. However, it is not easy to differentiate these from toxic stocks, which need to be discarded at the right time.
Overpriced toxic stocks are generally susceptible to external shocks. Also, these stocks are burdened with high amount of debts.
Investors may gain from precisely identifying toxic stocks with the help of an investing strategy called short selling. This strategy allows investors 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, spotting toxic stocks and abandoning or short selling them at the right time is the key to protect your portfolio from big losses.
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.