Is American Oriental Bioengineering a Sell?

Should you sell American Oriental Bioengineering (NYSE: AOB) 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 American Oriental Bioengineering and will evaluate its price, valuation, margins, and liquidity. Let's get started!

Don't sell on price
Over the past 12 months, American Oriental Bioengineering is down 48.6% versus an S&P 500 return of 11.3%. Investors in American Oriental Bioengineering 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 American Oriental Bioengineering investing thesis. That said, it helps to view the price in historical context. Below, I compare American Oriental Bioengineering'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 for context.

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

As you can see, American Oriental Bioengineering is significantly 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 American Oriental Bioengineering's valuation. I'm comparing American Oriental Bioengineering's recent P/E ratio of 6.1 to where it's been over the past five years.

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

American Oriental Bioengineering'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, American Oriental Bioengineering 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 American Oriental Bioengineering's gross margin over the past five years:

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

Despite some weakness in 2009, American Oriental Bioengineering has relatively stable gross margins, which tend to dictate a company's overall profitability. This is solid news; however, American Oriental Bioengineering 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 American Oriental Bioengineering. 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 75,000-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 American Oriental Bioengineering. 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 American Oriental Bioengineering's stock pitch page to see the verbatim reasons behind the ratings.

Short interest is at a rather high 7.4%. This typically indicates there are large institutional investors are betting against the stock.

Now, let's study American Oriental Bioengineering'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.

American Oriental Bioengineering has been taking on some additional debt over the past five years. Despite increasing equity over the same time period, debt-to-equity is up significantly. This is a bad sign, based on the trend alone. The Fool considers a debt-to-equity ratio below 50% to be healthy.  American Oriental Bioengineering is currently below this level, at 30.9%, but we should definitely watch the trend here.

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If American Oriental Bioengineering had to convert all of its assets to cash in one year, how many times over could the company cover its liabilities? American Oriental Bioengineering has a current ratio of 4.3. This is a healthy sign. I like to see companies with current ratios above 1.5.

Lastly, it is highly beneficial to determine whether American Oriental Bioengineering 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 American Oriental Bioengineering.

The final recap

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

Remember to add American Oriental Bioengineering 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.