by Staff Reports Money Morning, Money Morning
Special Report from Money Morning
2021 is shaping up to be a breakout year for stocks. Some stocks, at least. A lot more stocks will struggle. We’re here to make sure they don’t wind up weighing down your portfolio.
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The pandemic has accelerated changes in how we live and do business. That’s been great for some companies, like Zoom Communications Inc. (NASDAQ: ZM). It’s going to get a lot worse for some other stocks.
These will be stocks to avoid in 2021. And we’ll show you not only how to find these stocks on your own, but we’ll show you five stocks to steer clear of too.
While our team here at Money Morning has been hard at work helping you make the most of the post-COVID-19 rally and finding new trends and companies to invest in for 2021, we also want to make sure you avoid some popular stocks that could wind up as 2021 busts.
You see, while major indexes hit record highs to close out 2020, not all stocks did so well. Far from it. When the markets reclaimed positive territory on the year back in July, nearly two stocks were losing value to every one stock that gained value.
Companies like Amazon.com Inc. (NASDAQ: AMZN) lifted indexes higher thanks to their $1.6 trillion market cap and 80% year-to-date gains. But that simply masked the many more companies that struggled and bogged down portfolios.
More than a few stocks have been swept up in the colossal run-up off the March lows that haven’t earned their sky-high share prices. And some of these future clunkers are Internet and media darlings thanks to the returns they’ve brought shareholders so far.
Holding one of these stocks could be like holding a ticking time bomb. Once that first bad earnings report rolls in or a big investor hits the “sell” button, the share price could fall like a house of cards, and you don’t want to be the one left with the mess.
By spring of 2021, most of us will have had a chance to get vaccinated against COVID-19 and start moving the world toward something resembling normal.
What other surprises 2021 will have in store for us remains to be seen.
Let’s start with how to find these risky stocks in 2021, and then we’ll show you a few of these stocks to sell or avoid altogether in the new year.
6 Signs of When to Sell a Stock
The key to knowing when to sell a stock or avoid one outright is to not make decisions based on opinions or let personal bias get in the way of smart decision-making.
Maybe you’ve seen a stock go on such a tear that you want to buy into it and hope it happens again. Maybe you already own one of these stocks and can’t fathom cutting ties with a company that’s made you money.
But these are biases that could hold you back.
Instead, let’s look for those red flags that have been reliable indicators that a stock is on thin ice.
There are six signs of a stock to sell, and you can find them all in the financial statements, insider and institutional activity, and short interest.
You should give serious thought to selling or reducing position in any stocks that are showing these signs. If you do not already own them, you should avoid them until the situation changes for the better.
Using what we can see and know is a much smarter way of determining where potential pitfalls may lay than gut instinct or listening to the talking heads on TV.
The first red flag is a stock in an overbought sector.
Knowing the overbought sectors is critical when it comes to avoiding stocks that could be a big loser in early 2021. To help me find these sectors, I look at the relative strength of sector ETFs. Sector ETFs with relative strength readings over 75 have historically underperformed.
The last 10 years have been one of the best periods in history, so the fact that owning overbought ETFs lost money makes this a big red flag.
This will help spot stocks that could be set up for an enormous fall as the new year begins. The biggest positions in those ETFs will see massive uninformed forced selling when traders start to take profits.
As the first quarter begins, we could see asset allocators begin to move money out of high performing sectors and into those that need to catch up. This is a favored way of rebalancing large pension funds and endowment portfolios, and it could have a trickle effect across the market.
That will bring even more selling pressure into the sector ETFs of top-performing sectors with high relative strength readings and the stocks they hold.
Second, I look for stocks that trade at high multiples of sales and have rising short interest.
These stocks also tend to underperform in rising markets and fall much further than the indexes when markets do sell off. Avoiding stocks like that after the move in stocks we have seen in recent months can help us avoid huge losses when markets correct.
They may not do so on your preferred timetable, but markets always correct.
Third, I look at the 200-day moving average.
When a stock crosses below its 200-day moving average, it is also usually a good idea to sell your position. If you really love the stock, you can consider repurchasing it if it trades to a huge discount to the 200-day, but all too often, that initial cross below the 200-day moving indicates that a new bear market in that stock or asset class has begun.
Fourth, companies constantly selling stock or debt are also vulnerable to sharp price declines.
If companies cannot fund operations out of current free cash flows, then they are heading for the corporate junkyard.
There are some exceptions to that rule. REITs and BDC may raise capital to take advantage of new opportunities to buy assets. Operating businesses, however, have to be able to self-fund at some point.
Fifth, companies with declining fundamentals after a big runup are also candidates to see their stock drop in 2021.
If returns on equity and asset start to decline, earnings and cash flows will also begin to drop. Then analysts start to lower estimates and downgrade the stock. Then the real selling begins.
One of the best ways to spot deteriorating fundamentals is to track quarterly changes in a company’s F-score. The financial scoring system developed by Professor Joseph Piotroski measures variables in the company’s financial statements to determine its fundamental health.
The higher the F-score, the better the company’s financial condition and prospects.
A score moving higher is fantastic.
A falling score is another red flag.
Sixth, insider cluster sales are highly predictive of underperformance in the year ahead.
A solitary insider selling has little to no significance. The sale could be motivated by estate planning, the purchase of a vacation, a dream wedding for a daughter, and so on. This is routine and not something to overthink.
However, when several insiders are selling lots of stock right around the same time, you have to ask why. These are the people who know all about the company’s business and prospects, and if a lot of them are selling at the same time, do we really want to be buying?
Now that we’ve solidified our red flags, we can get to the fun part.
Let’s take a look at some top stocks right now that are showing these signs of potential decline.
That makes them the stocks to sell or avoid in 2021…
5 Stocks to Sell or Avoid in 2021
AutoZone
Shares of AutoZone Inc. (NYSE: AZO) have fallen back below its 200-day moving average after the company reported its most recent earnings. It seems traders had been hoping for better gains in sales and profits than the company actually reported.
There are also genuine concerns that a slow rollout of the coronavirus vaccines could slow down sales in the first quarter of 2021. Millions of people are still out of work, and without wide distribution of the vaccines, it could be a while before the economy springs back to life.
Some insiders seem to be a little concerned as well. Despite the stock being weak in recent months, we have seen some stock selling by the people running the company.
Autozone shares may be entering into a new bear market now that it is back under its 200-day moving average. Investors considering the stock should avoid purchasing shares now and wait for a better entry point.
TechTarget
TechTarget Inc. (NASDAQ: TTGT) is another company that has seen its stock price continue to soar even as its fundamental conditions began to slip.
TechTarget distributes free content to a list of IT professionals that help vendors develop qualified sales leads. IT firms pay for these leads and the data TechTarget generates from its content.
TechTarget has been a solid growth performer, but the fundamentals appear to be slowing even as the stock has increased by over 100% in the past year.
In 2020, TechTarget has seen its F-score fall from a solid 8 to just 4.
The stock has seen recent selling by multiple insiders, including the chair, CEO, and CFO.
The company probably has a bright future, but for now, I would delay any new purchases until the fundamentals improve.
Tesla
Any list of stocks to avoid in 2021 wouldn’t be complete without Tesla Inc. (NASDAQ: TSLA).
If you are a momentum trader with a massive appetite for risk, have at it. The volatile stock is your dream date.
If you are an investor who wants to buy and hold for a long time, you need to steer clear. Tesla has so many red flags it looks like the cheering section at a Kansas City Chiefs home game.
More than 150 ETFs hold shares of Tesla right now.
The stock is the largest holding in the SPDR NYSE Technology ETF (XNTK) at 13% of the portfolio.
If we see an allocation away from tech stocks that have had soared in 2020, Tesla will see a wave of forced selling.
Tesla has also been raising cash by selling stock. So far, in 2020, the company has done three stock offerings to raise cash.
That’s good for Tesla – not so good for shareholders.
Shares of Tesla are up more than 800% in the past year and over 600% in 2020 alone.
Insiders have taken advantage of the move higher as they have been selling enormous amounts of stock all year.
While I would never suggest shorting the Tesla’s shares, I would strongly advise not buying the stock here after the historic run-up in price. Tesla may well be the future of automaking, but that potential is more than baked into the price right now.
Elon Musk is the ultimate showman and an incredible innovator. However, there is a real chance that Tesla is not the market leader in either electric cars or energy storage. There are much larger, better-financed companies looking at these markets.
There is a significant chance that long-term investors buying at current prices will be very disappointed.
Sunrun
Sunrun Inc. (NASDAQ: RUN) is another company that has had a fantastic 2020. This company is in the rooftop solar business and is having a great year. Solar has been a beneficiary of the stay at home and get off the grid movement caused by the COVID-19 pandemic. There’s been a wave of people looking to become more self-sufficient, and installing solar is a big part of achieving that.
While we love the alternative energy business for the long term, Sunrun also has more than one red flag warning us to steer clear for now.
The stock has moved up more than 340% so far this year. While that is impressive, it makes the stock vulnerable to portfolio rebalancing. The largest shareholders a Sunrun are companies like Blackrock Inc. (NYSE: BLK), Vanguard, and State Street Corp. (NYSE: STT). All of these firms are best known for their index fund offerings.
Sixty-seven ETFs own shares of Sunrun, making the stock vulnerable to uninformed forced selling if large funds take profits and reallocate money in renewable energy stocks after this year’s colossal move.
Even as Sunrun shares have powered higher, there are indications that the fundamentals of the company are deteriorating. Sunrun’s F-score dropped a notch to 2 this last quarter. At that level, the stock would be considered a sell candidate by the ranking system due to poor financial conditions and bleak prospects.
Sunrun has minuscule accounting earnings but is producing negative cash flows right now. Both the share count and amount of long-term liabilities have increased in 2020, indicating that they are selling stock and debt to finance the business.
That’s not sustainable for the long run.
The people running Sunrun seem to think it is time to cash in some gains as they have been steady sellers of the stock.
I would consider taking profits if I owned the sock. Avoid buying until conditions improve if you are considering buying the stock.
CBOE Global Markets
Finally, CBOE Global Markets Inc. (BATS: CBOE) saw its stock drop below its 200-day moving average this week and may be entering a new bear market.
At first glance, that would seem impossible, as we have seen the rise of a whole new crowd of new, young options traders this year during the pandemic. As of the end of November, options trading volume at the exchange has swelled by 37% year over year.
In November, the CBOE set a record with 1,035,338 contracts, surpassing the previous record of 1,033,882 contracts set in February 2020.
I think traders are worried that the newbies minted in 2020 are not going to last long. If you look at some of the incredibly risky trades being done on Robinhood and other free and low-cost trading platforms, the consensus among professional traders is that it is only a matter of time before the new kids on the block are back to making $5 football bets and wondering what Mom is making for dinner.
That could easily lead to falling volumes and lowered earnings for the CBOE in 2021.
Avoiding big losses is just as important as finding big gains in the search for long-term stock market profits. Using these red flags can help you weed out and avoid some potential disasters.
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