Is Chevron a Sell?

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

Don't sell on price
Over the past 12 months, Chevron has risen 8.7% versus an S&P 500 return of 11.3%. Investors in Chevron are perhaps 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 Chevron investing thesis. For historical context, let's compare Chevron'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:

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

Chevron is basically at its 52-week high. This means we need to dig into the valuation to ensure that these new highs are justified.

Potential sell signs
First up, we'll get a rough idea of Chevron's valuation. I'm comparing Chevron's recent P/E ratio of 10.1 to where it's been over the past five years.

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

Chevron's P/E is higher than its five-year average, which could indicate the stock is overvalued. A high P/E isn't always a bad sign, since the company's growth prospects may also be increasing alongside the market's valuation. However, it definitely indicates that, on a purely historical basis, Chevron looks expensive.

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 Chevron's gross margin over the past five years:

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

Chevron is having no trouble maintaining its gross margin, which tends to dictate a company's overall profitability. This is solid news; however, Chevron 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 Chevron. 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 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.

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

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

Here, short interest is at a mere 1.2%. This typically indicates few large institutional investors are betting against the stock.

Now, let's study Chevron'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.

Chevron has done a good job of reducing its debt over the past five years. When we take into account increasing total equity over the same time period, this has caused debt-to-equity to decrease, as seen in the above chart. Based on the trend alone, that's a good sign. I consider a debt-to-equity ratio below 50% to be healthy, though it varies by industry. Chevron is currently below this level, at 10.4%.

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If Chevron had to convert its current assets to cash in one year, how many times over could the company cover its current liabilities? As of the last filing, Chevron has a current ratio of 1.66. This is a healthy sign. I like to see companies with current ratios equal to or greater than 1.5.

Finally, it's highly beneficial to determine whether Chevron 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 Chevron.

The final recap

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

Remember to add Chevron 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, be sure to read this article detailing how I missed out on more than $100,000 in gains through wrong-headed selling.