Selling Empire District Electric? Here's What You Need to Know First

Should you sell Empire District Electric (NYSE: EDE) 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 and the recent volatility throughout early August. In this series, 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 Empire District Electric, ready to evaluate its price, valuation, margins, and liquidity. Let's get started!

Don't sell on price
Over the past 12 months, Empire District Electric is down 3.5% versus an S&P 500 return of 9.1%. Investors in Empire District Electric 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 Empire District Electric investing thesis. For historical context, let's compare Empire District Electric'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.

As you can see, Empire District Electric 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 Empire District Electric's valuation. I'm comparing Empire District Electric's recent P/E ratio of 15.5 to where it's been over the past five years.

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

Empire District Electric'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, Empire District Electric 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 Empire District Electric's gross margin over the past five years:

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

Despite a dip four years ago, Empire District Electric is having no trouble maintaining and growing its gross margin, which tends to dictate a company's overall profitability. This is solid news; however, Empire District Electric investors need to keep an eye on this over the coming quarters. If margins dip again, you'll want to know why.

Next, let's explore what other investors think about Empire District Electric. 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 180,000-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 bearish on Empire District Electric. 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 Empire District Electric's stock pitch page to see the verbatim reasons behind the ratings.

Here, short interest is at a high 6.6%. This typically indicates that large institutional investors are betting against the stock.

Now let's study Empire District Electric'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.

Empire District Electric has been taking on some additional 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 remain near its five-year average, as seen in the above chart. I consider a debt-to-equity ratio below 50% to be healthy, though it varies by industry. Empire District Electric is currently above this level, at 108.7%.

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If Empire District Electric 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, Empire District Electric has a current ratio of 1.34. Empire District Electric could cover its current liabilities, but it's still below a healthy level of 1.5.

Finally, it's highly beneficial to determine whether Empire District Electric 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 Empire District Electric.

The final recap

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

In order to do that, I strongly recommend clicking here to add Empire District Electric to My Watchlist  to help you keep track of all of our ongoing coverage of the company.