Time to Sell Archer Daniels Midland?

Should you sell Archer Daniels Midland (NYSE: ADM  ) 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 Archer Daniels Midland, ready to evaluate its price, valuation, margins, and liquidity. Let's get started!

Don't sell on price
Over the past 12 months, Archer Daniels Midland has risen 12.2% versus an S&P 500 return of 11.3%. Investors in Archer Daniels Midland have every reason to be proud of their returns, but is it time to take some off the top? Not necessarily. Short-term outperformance alone is not a sell sign. The market may be just beginning to realize the true, intrinsic value of Archer Daniels Midland. For historical context, let's compare Archer Daniels Midland'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

Archer Daniels Midland

$33.27

$33.55

$49.00

Bunge (NYSE: BG  )

$60.65

$74.04

$135.00

Kraft Foods (NYSE: KFT  )

$31.65

$32.00

$37.20

Fresh Del Monte Produce (NYSE: FDP  )

$22.04

$24.77

$39.80

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

Archer Daniels Midland is basically at its 52-week high. This means we need to dig into the valuation to ensure that these previously untested highs are justified.

Potential sell signs
First up, we'll get a rough idea of Archer Daniels Midland's valuation. I'm comparing Archer Daniels Midland's recent P/E ratio of 11.1 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.

Archer Daniels Midland'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, Archer Daniels Midland 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 Archer Daniels Midland'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.

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

Next, let's explore what other investors think about Archer Daniels Midland. 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 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 (% of Float)

Archer Daniels Midland

4

2.1

Bunge

3

7.2

Kraft Foods

4

1.5

Fresh Del Monte Produce

3

4.4

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

The Fool community is rather bullish on Archer Daniels Midland. 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 Archer Daniels Midland's stock pitch page to see the verbatim reasons behind the ratings.

Here, short interest is at a mere 2.1%. This typically indicates few large institutional investors are betting against the stock.

Now, let's study Archer Daniels Midland'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.

Archer Daniels Midland has been taking on some additional debt over the past five years. Even with increasing total equity over the same time period, debt-to-equity has increased, 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. Archer Daniels Midland is just above this level, at 51.7%.

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If Archer Daniels Midland had to convert its current assets to cash in one year, how many times over could the company cover its liabilities? As of the last filing, Archer Daniels Midland has a current ratio of 2.12. This is a healthy sign. I like to see companies with current ratios greater than 1.5.

Finally, it's highly beneficial to determine whether Archer Daniels Midland 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 Archer Daniels Midland.

The final recap

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

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

If you haven't had a chance yet, but sure to read this article detailing how I missed out on more than $100,000 in gains through wrong-headed selling.

Jeremy Phillips does not own shares of the companies mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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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 30, 2010, at 9:41 AM, dlhdouble wrote:

    Is this part 1 of a multipart series? You touched the surface, now say why the number are where they are. You can't expect to be a successful stock picker without looking beyond the numbers. A few quick things to point out. 1. the 5 year stock price reflects the ethanol boom. 2. competitors are not very comparable to ADM. 3. debt will go down as ADM is close to completing their "Big 7" construction projects.

    What does this company have on the horizon? How is the grain crop this year? Will people get over their irrational fear of high fructose corn syrup?

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