Is GigaMedia a Sell?

Should you sell GigaMedia (Nasdaq: GIGM) 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 GigaMedia, and I'll evaluate its price, margins, and liquidity. Let's get started!

Don't sell on price
Over the past 12 months, GigaMedia is down 59% versus an S&P 500 return of 11.3%. Investors in GigaMedia are no doubt disappointed with their returns, but is now the time to cut and run? Not necessarily. A short-term price decline alone is not a sell sign. The market may be missing the critical element of your investing thesis. For historical context, let's compare GigaMedia'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, GigaMedia is well below 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, 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 GigaMedia's gross margin over the past five years:

Source: Capital IQ, a division of Standard & Poor's; prices in millions.

GigaMedia is having no trouble maintaining its gross margin, which tends to dictate a company's overall profitability. This is solid news; however, GigaMedia 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 GigaMedia. 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 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; NM = not meaningful.

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

Short interest is at a mere 2%. This typically indicates very few large institutional investors are betting against the stock.

Now, let's study GigaMedia'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.

GigaMedia has been taking on some 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 be choppy, but increase, as seen in the above chart. This is a bad sign, based on the trend alone. I consider a debt-to-equity ratio below 50% to be healthy, though it varies by industry. GigaMedia is currently below this level, at an extremely strong 5.7%.

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If GigaMedia had to convert all of its assets to cash in one year, how many times over could the company cover its liabilities? GigaMedia has a current ratio of 2.8. This is a healthy sign. I like to see companies with current ratios above 1.5.

Finally, it is highly beneficial to determine whether GigaMedia 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 GigaMedia.

The final recap

GigaMedia has failed one of my quick tests that would make it a sell. And even with a negative debt-to-equity trend, the company's current levels are well below anything I'd be worried about.

This is great, but does this mean you should hold your GigaMedia shares? Not necessarily. Just keep your eye on these trends over the coming quarters.

Remember to add GigaMedia to My Watchlist  to help you keep track of all our coverage of the company on Fool.com.

What companies would you like me to cover next in this series? Please leave your comments below.