A Simple Trick to Know Which Stocks to Sell

Andy Snyder|September 8, 2022

It’s the question we get asked the most these days.

“Which stocks should I sell to avoid the mayhem?”

It’s a sign of the times that our dear readers would rather learn what to avoid… than what offers a shot at riches.

We’ve had a good time betting against the losers in our popular Alpha Money Flow subscription service. We’re 3-for-3 on our short plays… and entered a new play on Tuesday.

In that service, we focus tightly on trading volume. We track who is buying and who is selling… and we look for key crossovers in that activity.

It’s admittedly a bit complex… not for the average DIY investor.

But there is a quick-and-easy strategy that anybody with a bit of basic screening knowledge can use. It, too, plays a role in how we look for “shortable” stocks in Alpha Money Flow.

Growth Shrinkage

It has to do with the growth premiums that sent equities to record highs over the last few years.

For most of the stock market’s history, the typical P/E ratio was about 15. In other words, investors were willing to pay a price equal to 15 times a stock’s annual earnings.

The more growth a company sees, the higher its P/E ratio will be. After all, with strong profit growth, a company with a P/E of 15 today would have one of just 10 tomorrow. It’s worth paying the multiple to get in.

Thanks to artificially low interest rates, the last few years have been anything but typical, though.

The multiple on the S&P 500 surged above 20… then above 25.

Investors expected growth… and lots of it.

Obviously, things have changed. Forgetting today’s politically driven fight over definitions, we’re in a recession. Widespread growth is now merely an entry in the history books – and we might not see it again for quite a while.

That’s why stocks have fallen so far so quickly. Their growth expectations have been slashed, which pulls down the earnings multiple that investors are willing to pay.

But here’s the thing… the important part.

You Paid What?!

The market hasn’t slashed all growth expectations. There are plenty of stocks that still trade at tremendously high P/Es.

Our last short play in Alpha Money Flow, for instance, had a P/E of over 200. The market expects strong, double-digit growth from this young company over the next few years.

Just a hint of a slowdown can take the knees out of such a strong figure. And that’s exactly what happened when the company released its most recent earnings report. Expectations weren’t met, and the share price fell.

It means the very first things we should be selling are stocks with sky-high earnings multiples that are unlikely to live up to their growth expectations.

Anything with a P/E over 50 is suspect these days.

Of course, just looking at an earnings multiple doesn’t tell us much about growth. That’s where one of our favorite indicators comes home to roost… the PEG ratio.

It’s simple. This growth-focused ratio merely divides a stock’s P/E ratio by its earnings growth rate.

The higher the figure, the more growth there is priced in.

Traditionally, a figure below 1.0 represents a bargain. But for shorting or simply dumping overpriced stocks, we target plays with PEGs over 2.0. They represent a company with strong (likely too strong) growth expectations.

Screen for stocks with a P/E over 50 and a PEG of 2.0 or higher and you’ll get a strong list of companies that are likely worth selling.

They’re overpriced in a market where growth will become increasingly hard to find.

Godspeed…