Selling Terra Nitrogen? Here's What You Need to Know First

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

Don't sell on price
Over the past 12 months, Terra Nitrogen has risen 86.2% versus an S&P 500 return of 9.1%. Investors in Terra Nitrogen 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 Terra Nitrogen. For historical context, let's compare Terra Nitrogen'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.

Terra Nitrogen 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 Terra Nitrogen's valuation. I'm comparing Terra Nitrogen's recent P/E ratio of 9.0 to where it's been over the past five years.

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

Terra Nitrogen'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, Terra Nitrogen 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 Terra Nitrogen's gross margin over the past five years:

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

Terra Nitrogen has been able to grow its gross margin, which tends to dictate a company's overall profitability. This is great news; however, Terra Nitrogen 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 Terra Nitrogen. 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 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 bullish on Terra Nitrogen. 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 Terra Nitrogen's stock pitch page to see the verbatim reasons behind the ratings.

Here, short interest is at a mere 0.7%. This typically indicates few large institutional investors are betting against the stock.

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If Terra Nitrogen 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, Terra Nitrogen has a current ratio of 6.27. 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 Terra Nitrogen 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 Terra Nitrogen.

The final recap

Terra Nitrogen has failed none of the quick tests that would make it a sell. This is great, but does it mean you should hold your Terra Nitrogen shares? Not necessarily. Just keep your eye on these trends over the coming quarters.

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