Accurate identification of overpriced stocks and correctly priced stocks is the key to investing success. But this is a tough task as the overhyped stocks and the fairly priced stocks are intermingled in the marketplace in a very deceptive way. Investors who can spot the over-bubble toxic stocks and abandon them at the right time are likely to make profits.

Usually, toxic stocks are vulnerable to external shocks and are encumbered with huge debts. Also, the unjustifiably high price of toxic stocks can’t sustain for long as the current price of these stocks exceeds their intrinsic values. Over time, these stocks are bound to result in losses for investors.

Exaggerated 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 a longer period of time, you are sure to see big erosion in your wealth.

However, if you can figure out the toxic stocks precisely, you may benefit 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 identifying stocks with robust growth potential, picking up toxic stocks and abandoning them at the right time is the key to guard your portfolio from big losses or make profits by short selling them.

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.

Here are five of the 22 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, the current quarter estimates declined 5.9% to 16 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.

Covanta Holding Corporation (CVA - Free Report) is a Morristown, NJ-based alternative energy company that provides waste and energy services in the U.S. and Canada. Over the past 30 days, its current quarter estimates widened from a loss of 18 cents per share to a loss of 20 cents.  The company has a Zacks Rank #3.

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. Over the last 30 days, its current quarter estimate has narrowed down from a penny per share to a “no loss no profit” situation. The company has a Zacks Rank #3.

Wilmington, DE-based Incyte Corporation (INCY - Free Report) is a drug discovery company. Over the last 30 days, its current quarter estimate widened from a loss of 72 cents per share to a loss of 83 cents. Incyte carries a Zacks Rank #3.

Waltham, MA-based AMAG Pharmaceuticals, Inc. (AMAG - Free Report) is a biopharmaceutical company that manufactures, develops, and commercializes therapeutics for women health, anemia management, and cancer supportive care in the U.S. AMAG Pharmaceuticals carries a Zacks Rank #3.