Is American Oriental Bioengineering a Sell?

Should you sell American Oriental Bioengineering (NYSE: AOB  ) today?

The decision to sell a stock you've researched and followed for months or years is never an easy one. If they fall in love with their stock holdings, investors become vulnerable to confirmation bias -- listening only to information that supports their 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 American Oriental Bioengineering and will evaluate its price, valuation, margins, and liquidity. Let's get started!

Don't sell on price
Over the past 12 months, American Oriental Bioengineering is down 48.6% versus an S&P 500 return of 11.3%. Investors in American Oriental Bioengineering 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 American Oriental Bioengineering investing thesis. That said, it helps to view the price in historical context. Below, I compare American Oriental Bioengineering'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 for context.

Company

Recent Price

52-Week High

5-Year High

American Oriental Bioengineering

$2.41

$4.92

$14.50

China Agritech (Nasdaq: CAGC  )

$11.56

$30.75

$39.80

China Sky One Medical (Nasdaq: CSKI  )

$7.57

$25.45

$25.50

Mindray Medical International Limited (NYSE: MR  )

$29.57

$40.35

$45.20

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

As you can see, American Oriental Bioengineering is significantly 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 American Oriental Bioengineering's valuation. I'm comparing American Oriental Bioengineering's recent P/E ratio of 6.1 to where it's been over the past five years.

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

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

American Oriental Bioengineering'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, American Oriental Bioengineering looks cheap.

Now, let's look at gross margins over time. They represent 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 American Oriental Bioengineering'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.

Despite some weakness in 2009, American Oriental Bioengineering has relatively stable gross margins, which tend to dictate a company's overall profitability. This is solid news; however, American Oriental Bioengineering investors need to keep an eye on this over the coming quarters. If margins begin to dip, you'll want to know why.

Next, let's explore what other investors think about American Oriental Bioengineering. We love the contrarian view here at Fool.com, but we don't mind cheating off 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 75,000-strong community of individual analysts rate 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 (out of 5)

Short Interest (Float)

American Oriental Bioengineering

****

7.4

China Agritech

**

26.3

China Sky One Medical

***

16.3

Mindray Medical International Limited

*****

20.9

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

The Fool community is rather bullish on American Oriental Bioengineering. We typically like to see our stocks rated at four or five stars. Anything below that could be a less-than-bullish indicator. I highly recommend you visit American Oriental Bioengineering's stock pitch page to see the verbatim reasons behind the ratings.

Short interest is at a rather high 7.4%. This typically indicates there are large institutional investors are betting against the stock.

Now, let's study American Oriental Bioengineering'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.

American Oriental Bioengineering has been taking on some additional debt over the past five years. Despite increasing equity over the same time period, debt-to-equity is up significantly. This is a bad sign, based on the trend alone. The Fool considers a debt-to-equity ratio below 50% to be healthy.  American Oriental Bioengineering is currently below this level, at 30.9%, but we should definitely watch the trend here.

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If American Oriental Bioengineering had to convert all of its assets to cash in one year, how many times over could the company cover its liabilities? American Oriental Bioengineering has a current ratio of 4.3. This is a healthy sign. I like to see companies with current ratios above 1.5.

Lastly, it is highly beneficial to determine whether American Oriental Bioengineering 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 American Oriental Bioengineering.

The final recap

American Oriental Bioengineering has failed only two of my quick tests that would make it a sell. This is great, but does this mean you should hold your American Oriental Bioengineering shares? Not necessarily. Just keep your eye on these trends over the coming quarters.

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

Any suggestions on how I could improve this series? What companies would you like me to cover next? Please leave your comments below.

Jeremy Phillips does not own shares of the companies mentioned. 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 Motley Fool has a disclosure policy.


Read/Post Comments (15) | Recommend This Article (17)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 04, 2010, at 5:12 PM, statsguy wrote:

    The author does a good job with the technical analysis. but what is lacking is the soft stuff- trust in management. With Chinese companies we never really know what we're getting, and in the case of AOB, there have been some fairly shady internal problems as of late. This is always troublesome in a company, but with a company located in a country w/o the same rules of disclosure found in the US, it's a serious red flag. I've sold most of mine but am keeping a bit for a 2011 tax loss.

  • Report this Comment On October 05, 2010, at 7:54 AM, pondee619 wrote:

    Woudn't a large short interest percentage point towards a stock where all the sellers have already sold (leaving mostly buyers/coverers) and lead to a short squeeze? AOB sjure looked like a candidate for your portfolio. All it has done, though, is go down.

    Does the fool ever answer the question poised in its headline? "American Oriental Bioengineering has failed only two of my quick tests that would make it a sell" but it is not "necessarily" a hold.

  • Report this Comment On October 05, 2010, at 10:42 AM, RHinCT wrote:

    "Does the fool ever answer the question poised in its headline?"

    They always answer it by saying... that it is up to you to decide. That's just the way TMF is.

  • Report this Comment On October 05, 2010, at 10:58 AM, pondee619 wrote:

    So, the answer is no?

  • Report this Comment On October 05, 2010, at 11:52 AM, clintspicks wrote:

    The answer to your question pondee is "yes." And the answer to the headline is "maybe, maybe not."

  • Report this Comment On October 05, 2010, at 1:24 PM, TMFtheEdge wrote:

    AOB's revenue growth rate has slowed significantly due to it's change of focus to R&D (by virtue of establishing an R&D centre) while it's SG&A has been rising -- the business model has certainly changed compared to the past and perhaps needs to regain creditability before it returns to the P/E levels of the past.

  • Report this Comment On October 05, 2010, at 3:32 PM, pondee619 wrote:

    "the answer to the headline is "maybe, maybe not.""

    Please tell me you're kidding. "Maybe, maybe not" is The ANSWER?

    If AOB failed only two of the sell tests, why isn't it a hold? Is there something withheld from the "story"? Is the failure of only two tests reason to sell? Should I "hold" my shares while "keep(ing my) your eye on these trends over the coming quarters"?

    The fool raised the question, are you really satisfied with the "answer"?

  • Report this Comment On October 05, 2010, at 4:12 PM, dicartacash wrote:

    Jeremey, I appreciate that you gave us your method for analyzing a stock, but I am not sure how to interpret your advice. Given that one of the most important rules to investing is to "stick with your system", what is your system telling you? More specifically, what would be the "tipping point" that would tell you to sell? One more red thumb? Two more? Or are you making a point, and confirmation bias has set in and you are just unwilling to unload the stock? ;-)

  • Report this Comment On October 05, 2010, at 8:10 PM, TMFMoby wrote:

    dicartacash - My goal with this series is that I want to show some potentially negative trends/metrics to Fools that might be holding AOB (or other stocks in the series.)

    I've fallen in love with a few stocks over the years, and it has damaged my portfolio. This is largely because I didn't appreciate some obvious negative trends as much as I should have. I want to help others through my mistakes, largely by looking for negative items in their stocks.

    If you're already keeping an eye on the gross margins and debt, and you knew there is short interest (though it's relatively light when vs. the comparison companies,) then you can move on into the softer items that statsguy rightfully references.

    Think of the series as a smoke-test and a starting-point for your and other Fools' portfolios.

    Foolishly,

    Jeremy

  • Report this Comment On October 07, 2010, at 8:07 AM, jamespeer wrote:

    AOB is trash but if you bought at $4 like I did, I wouldn't sell. Do not buy this stock because Tony Liu is a corrupt man and has a history of issuing shares, taking on more debt, and buying property with company cash without justifiable reason, his actions are beyond comprehension and only serve to diminish shareholder value. However, I can't see them going much lower based on the fundamentals (which we can now rely on as they have trusted auditors in place), which is why I am still holding..

  • Report this Comment On October 11, 2010, at 3:22 PM, PandJonB wrote:

    Consider how AOB gained access through a third party company to become listed on the exchange. It is not the most forthright way of conducting business. In my personal opinion I simply do not trust them, or the way that they do business.

  • Report this Comment On October 11, 2010, at 4:27 PM, oldengineer wrote:

    This article is one of many similar. First pose a question that I would like to know the answer to. Second, write some intersesting stuff. Third, state "Gee, I really don't know."

  • Report this Comment On October 11, 2010, at 8:12 PM, garrettmoore wrote:

    If you listen to anything coming from this site you aren't a Motley Fool, you're just a fool.

    Years ago I made my first stock purchase of AOB based upon a buy recommendation from this site. At that time, the stock was around $8 a share. After their recommendation, it steadily declined to around $2.50 a share, at which point Motley Fool then suggested selling. Then the stock pops 13% after their sell recommendation, and now they're preaching "buy" again.

    Seems like you could make a fortune doing the exact opposite of what these writers suggest.

    Garbage.

  • Report this Comment On October 17, 2010, at 2:17 PM, DougH11 wrote:

    Question: Is American Oriental Bioengineering a Sell?

    Answer: It was never a Buy.

  • Report this Comment On February 21, 2011, at 9:46 PM, xiaoju wrote:

    AOB's performance may look ok for the past several years. However, they may overstated a purchase price on the aquisition that occured in Year 2007. One of my friend is an executive in the pharmaceutical company, and he told me that AOB were isssued $30 million USD worth of stock to purchase one of the Chinese Pharamaceutical Company, but the actual purchase price was only $5million. Of course they have done enough home work to fool around in the audit. after I have aware the inside story of the acquisition, I will never buy their stock anymore.

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