Precise identification of correctly-priced stocks is the key to successful investing. However, in reality, overpriced toxic stocks and rightly-priced stocks are intertwined in such a way that it is difficult to distinguish between the two.  

Generally, overpriced toxic stocks are vulnerable to outside shocks. Moreover, these stocks are loaded with a large amount of debt. The price of these stocks is artificially inflated. The higher price of toxic stocks is only temporary in nature as it is higher than its intrinsic value.

Investors are likely to gain from accurate identification of 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 price falls.

While short selling excels in bear markets, it typically loses money in bull markets.

So, correctly identifying toxic stocks and discarding or short selling those at the right time is the key to guard 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 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 Buy-rated stocks that generally outperform the market.

Here are four of the 21 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. In the past seven days, the Zacks Consensus Estimate for current-year earnings per share has remained unchanged at 71 cents. The company has a Zacks Rank #3.

Leawood, KS-based AMC Entertainment Holdings, Inc. (AMC - Free Report) operates as a theatrical exhibition company primarily in the United States. Over the past 30 days, the Zacks Consensus Estimate for current-year earnings has declined from 26 cents to 22 cents. The stock currently has a Zacks Rank #3.

Covanta Holding Corporation (CVA - Free Report) is a Morristown, NJ-based alternative energy company that provides waste and energy services in the United States and Canada. In the past 30 days, the Zacks Consensus Estimate for current-year earnings per share has declined from 5 cents to 3 cents.

Frederick, MD-based U.S. Silica Holdings, Inc. (SLCA - Free Report) is a producer of industrial minerals, including sand proppants, whole grain silica, ground silica, fine ground silica, calcined kaolin clay, and aplite clay. Over the past 30 days, the Zacks Consensus Estimate for current-quarter loss per share has widened from 6 cents to 9 cents. The stock currently has a Zacks Rank #3.