Should You Sell Frontier Communications Today?

Should you sell Frontier Communications (NYSE: FTR) 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 Frontier Communications. Let's get started!

Don't sell on price
Over the past 12 months, Frontier Communications has risen 10.9% versus an S&P 500 return of 11.3%. It's likely that investors in Frontier Communications are disappointed with their market-matching 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 Frontier Communications investing thesis. That said, it helps to view the price in historical context. Below, I compare Frontier Communications' recent price with its 52-week and five-year highs. I've also included a few other businesses in the same or related industries for context.

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

Frontier Communications is basically at its 52-week high. This means we need to dig into the valuation to ensure that these previously untested prices are justified.

Potential sell signs
First up, we'll get a rough idea of Frontier Communications' valuation. I'm comparing Frontier Communications' recent P/E ratio of 19.3 to where it has been over the past five years.

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

Frontier Communications' 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, Frontier Communications 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 Frontier Communications' gross margin over the past five years:

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

Frontier Communications is having some trouble maintaining its gross margin, which tends to dictate a company's overall profitability. Frontier Communications investors need to keep an eye on this steady decline over the coming quarters.

Next, let's explore what other investors think about Frontier Communications. 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 CAPS' 170,000-strong community of individual analysts rates 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 in the middle of the road on Frontier Communications. 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 Frontier Communications' stock pitch page to see the verbatim reasons behind the ratings.

Short interest is at 5%, which typically indicates a few large institutional investors are betting against the stock.

Now, let's study Frontier Communications' debt situation, with a little help from the debt-to-equity ratio. This metric tells us how much debt the company has taken on, relative to its overall capital structure.

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

Frontier Communications' sky-high debt is around its five-year average. When we take into account decreasing total equity over the same time, this has caused debt-to-equity to increase, as seen in the above chart. This is a bad sign, based on the trend alone. The Fool considers a debt-to-equity ratio below 50% to be healthy. Frontier Communications is above this level, at a monstrous 1,849%.

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If Frontier Communications had to convert all of its assets to cash in one year, how many times over could the company cover its liabilities? Frontier Communications has a current ratio of 1.8. This is a healthy sign. I like to see companies with current ratios above 1.5.

Lastly, it is highly beneficial to determine whether Frontier Communications 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 Frontier Communications.

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

Remember to add Frontier Communications 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.