Toxic stocks may prove to be a threat to the performance of a portfolio. Such stocks may appear lucrative at first but turn out to be risky as one digs deeper. The risk of owning toxic stocks can be eliminated if investors remain vigilant about the performance of every stock that they own in their portfolio.
The performance of a stock mainly depends on the underlying strength of the company, which, in turn, is dependent on financial flexibility, legal standing and management’s decisions. Most companies issue debt to raise money to grow their businesses. But the problem begins when those companies are unable to generate enough profits to pay off their liabilities. Stock prices of such insolvent companies get wiped out within a few days or even within a few hours.
Such companies can be identified by careful examination of their financial statements, which reflect the financial position of the company. If the intrinsic value of the company appears lower than its stock price, the stock becomes overvalued and is prone to losing its value over time. This is when investors should consider discarding the stock.
The stock price of a company also depends on management’s decision and legal challenges associated with the company. If management is inexperienced or has a track record of making poor decisions, the company’s future and ultimately the performance of the stock are bound to go downhill. Investors can prevent themselves from such risks by keeping abreast of latest news on the company.
Diversification offers an opportunity to avoid the magnitude of losses associated with the risk of owning toxic stocks. Through diversification, one can invest in different stocks from different asset classes to limit their exposure to a particular stock.
The detection and removal of a toxic stock at the correct time is crucial to overall portfolio health. If investors can accurately determine toxic stocks, they can take advantage of short selling, which is the process of selling stock at higher prices and buying them back at lower prices.
Dutch Bros Inc. BROS, UBS Group AG UBS, CoStar Group, Inc. CSGP and Semtech Corporation SMTC are a few toxic stocks that you should dump from your portfolio.
Here is a winning strategy that will help you to identify 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 a 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 fiscal year and the next during the past 12 weeks points to analysts’ pessimism.
Zacks Rank more than #3 (Hold): We have not considered Buy/Hold-rated stocks that generally outperform or are in line with the market. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Here are four of the 25 toxic stocks that showed up on the screen:
Dutch Bros is an operator and franchisor of drive-thru shops, which focus on serving high-quality, hand-crafted beverages with unparalleled speed and superior services. The Zacks Consensus Estimate for BROS’s 2023 bottom line is pegged at a profit of 20 cents per share. The consensus mark has moved south from earnings of 36 cents per share to earnings of 20 cents per share over the past 90 days. Dutch Bros missed earnings estimates in two out of the last four quarters and beat once, with the average negative surprise being 11.9%. The company carries a Zacks Rank #5 (Strong Sell) and has a VGM Score of D.
UBS is a bank and the core operating company of the UBS Group. The Zacks Consensus Estimate for the 2023 bottom line is pegged at a loss of 69 cents per share, implying a year-over-year deterioration of 130.67%. The consensus mark has moved south from a loss of 63 cents per share to a loss of 69 cents per share over the past seven days. UBS beat earnings estimates in two out of the four trailing quarters and missed twice, with the average surprise being 2.09%. The company carries a Zacks Rank #4 (Sell) and has a VGM Score of F.
CoStar provides information services to the commercial real estate industry. The Zacks Consensus Estimate for CSGP’s 2023 bottom line is pegged at a profit of $1.09 per share, implying a year-over-year deterioration of 14.17%. The Zacks Consensus Estimate for the firm’s 2023 earnings has moved south from $1.16 per share to earnings of $1.09 per share over the past 60 days. CoStar beat earnings estimates in all four trailing quarters, with the average surprise being 21.52%. The company carries a Zacks Rank #4 and has a VGM Score of F.
Semtech designs, manufactures and markets a wide range of analog and mixed-signal semiconductors for commercial applications. The Zacks Consensus Estimate for SMTC’s 2023 bottom line is pegged at a profit of 48 cents per share, implying a year-over-year deterioration of 82.86%. The Zacks Consensus Estimate for the firm’s 2023 bottom line has moved south from earnings of $2.16 per share to earnings of 48 cents per share over the past 30 days. Semtech beat earnings estimates in three out of the four trailing quarters and missed in one, with the average surprise being 2.18%. The company carries a Zacks Rank #4 and has a VGM Score of F.
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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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