Time to Sell FirstEnergy?

Should you sell FirstEnergy (NYSE: FE  ) today?

The decision to sell a stock you've researched and followed for months or years is never easy. If you fall in love with your stock holdings, you risk becoming vulnerable to confirmation bias -- listening only to information that supports your theories, and rejecting any contradictions.

In 2004, longtime Fool Bill Mann called confirmation bias one of the most dangerous components of investing. This warning has helped my own personal investing throughout the Great Recession. Now, I want to help you identify potential sell signs on popular stocks within our 4-million-strong Fool.com community.

Today I'm laser-focused on FirstEnergy, ready to evaluate its price, valuation, margins, and liquidity. Let's get started!

Don't sell on price
Over the past 12 months, FirstEnergy is down 13.8% versus an S&P 500 return of 11.3%. Investors in FirstEnergy are no doubt disappointed with their returns, but is now the time to cut and run? Not necessarily. Short-term underperformance alone is not a sell sign. The market may be missing the critical element of your FirstEnergy investing thesis. For historical context, let's compare FirstEnergy's recent price to its 52-week and five-year highs. I've also included a few other businesses in the same or related industries:

Company

Recent Price

52-Week High

5-Year High

FirstEnergy $38.54 $47.77 $84.00
Southern (NYSE: SO  ) $37.24 $37.73 $40.60
NextEra Energy (NYSE: NEE  ) $54.39 $56.57 $73.80
Progress Energy (NYSE: PGN  ) $44.42 $44.82 $52.80

Source: Capital IQ, a division of Standard & Poor's.

As you can see, FirstEnergy is down from its 52-week high. If you bought near the peak, now's the time to think back to why you bought it in the first place. If your reasons still hold true, you shouldn't sell based on this information alone.

Potential sell signs
First up, we'll get a rough idea of FirstEnergy's valuation. I'm comparing FirstEnergy's recent P/E ratio of 13.2 to where it has been over the past five years.

Source: Capital IQ, a division of Standard & Poor's.

Source: Capital IQ, a division of Standard & Poor's.

FirstEnergy's P/E is lower than its five-year average, which could indicate the stock is undervalued. A low P/E isn't always a good sign, since the market may be lowering its valuation of the company because of less attractive growth prospects. It does indicate that, on a purely historical basis, FirstEnergy looks cheap.

Now, let's look at the gross margins trend, which represents the amount of profit a company makes for each $1 in sales, after deducting all costs directly related to that sale. A deteriorating gross margin over time can indicate that competition has forced the company to lower prices, that it can't control costs, or that its whole industry's facing tough times. Here is FirstEnergy's gross margin over the past five years:

Source: Capital IQ, a division of Standard & Poor's.

Source: Capital IQ, a division of Standard & Poor's.

FirstEnergy is clearly having issues maintaining its gross margin, which tends to dictate a company's overall profitability. FirstEnergy investors need to keep an eye on this troubling trend over the coming quarters.

Next, let's explore what other investors think about FirstEnergy. We love the contrarian view here at Fool.com, but we don't mind cheating off of our neighbors every once in a while. For this, we'll examine two metrics: Motley Fool CAPS ratings and short interest. The former tells us how Fool.com's 170,000-strong community of individual analysts rates the stock. The latter shows what proportion of investors are betting that the stock will fall. I'm including other peer companies once again for context.

Company

CAPS Rating

Short Interest (Float)

FirstEnergy *** 7.9
Southern **** 1.4
NextEra Energy ***** 1.4
Progress Energy **** 1.9

Source: Capital IQ, a division of Standard & Poor's.

The Fool community is in the middle of the road on FirstEnergy. We typically like to see our stocks rated at four or five stars. Anything below that is a less-than-bullish indicator. I highly recommend you visit FirstEnergy's stock pitch page to see the verbatim reasons behind the ratings.

Here, short interest is at a high 7.9%. This typically indicates that large institutional investors are betting against the stock.

Now, let's study FirstEnergy's debt situation, with a little help from the debt-to-equity ratio. This metric tells us how much debt the company's taken on, relative to its overall capital structure.

Source: Capital IQ, a division of Standard & Poor's.

Source: Capital IQ, a division of Standard & Poor's.

FirstEnergy has been taking on some additional debt over the past five years. When we take into account essentially unchanged total equity over the same time period, this has caused debt-to-equity to increase, as seen in the above chart. Based on the trend alone, that's a bad sign. I consider a debt-to-equity ratio below 50% to be healthy, though it varies by industry. FirstEnergy is above this level, at 168.5%.

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If FirstEnergy had to convert its current assets to cash in one year, how many times over could the company cover its liabilities? As of the latest filing, FirstEnergy has a current ratio of 0.62. This is a bad sign. The company's liabilities are greater than its assets, which means it could have liquidity issues in the short term.

Finally, it's highly beneficial to determine whether FirstEnergy belongs in your portfolio -- and to know how many similar businesses already occupy your stable of investments. If you haven't already, be sure to put your tickers into Fool.com's free portfolio tracker, My Watchlist. You can get started right away by clicking here to add FirstEnergy.

The recap

FirstEnergy has failed five of the quick tests that would make it a sell. Does it mean you should sell your FirstEnergy shares today solely because of this? Not necessarily, but keep your eye on these trends over the coming quarters.

Remember to add FirstEnergy to My Watchlist to help you keep track of all our coverage of the company on Fool.com.

What companies would you like me to cover next in this series? Please leave your comments below.

Jeremy Phillips does not own shares of the companies mentioned. Southern is a Motley Fool Income Investor pick. The Fool owns shares of and has written covered calls on NextEra Energy. Try any of our Foolish newsletter services free for 30 days.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Fool has a disclosure policy.


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