Should you sell E*TRADE Financial (Nasdaq: ETFC) 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 E*TRADE Financial, and will evaluate its price, margins, and liquidity. Let's get started!

Don't sell on price
Over the past 12 months, E*TRADE Financial is down 8.9%, versus a positive S&P 500 return of 11.3%. Investors in E*TRADE Financial 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 investing thesis. That said, it helps to view the price in historical context. Below, I compare E*TRADE Financial'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.

Company

Recent Price

52-Week High

5-Year High

E*TRADE Financial $14.57 $19.90 $277.60
Charles Schwab (NYSE: SCHW) $13.90 $19.95 $28.80
TD AMERITRADE Holding (Nasdaq: AMTD) $16.15 $21.30 $26.40
Jefferies Group (NYSE: JEF) $22.69 $30.99 $34.80

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

As you can see, E*TRADE Financial 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, 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 E*TRADE Financial's gross margin over the past five years:



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

E*TRADE Financial has had a choppy gross margin over the past five years, which makes sense given the financial crisis. Since this tends to dictate a company's overall profitability, 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 E*TRADE Financial. 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 150,000-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.

Company

CAPS Rating

Short Interest (Float)

E*TRADE Financial

4

4.4%

Charles Schwab

4

4.8%

TD AMERITRADE Holding

4

12.6%

Jefferies Group

2

17.2%

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

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

Short interest is a mere 4.4%. This typically indicates that very few large institutional investors are betting against the stock.

Now, let's study E*TRADE Financial'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.

E*TRADE Financial has done a good job of reducing its debt over the past five years. When we take into account decreasing 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 less than 50% to be healthy, though the optimum levels differ by industry. E*TRADE Financial is currently above this level, at 272.5%.

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If E*TRADE Financial had to convert all of its assets to cash in one year, how many times over could the company cover its liabilities? E*TRADE Financial has a current ratio of 2.6. This is a healthy sign. I like to see companies with current ratios above 1.5.

Finally, it is highly beneficial to determine whether E*TRADE Financial 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 E*TRADE Financial.

The final recap

Etfcsellingrecap

E*TRADE Financial has failed exactly none of my quick tests that would make it a sell. This is fantastic news, but does it mean that you should hold your E*TRADE Financial shares? Not necessarily. Remember that bears are primarily worried about the state of the assets on E-TRADE's balance sheet. Still, it's also a good idea to keep your eye on these trends over the coming quarters.

Remember to add E*TRADE Financial 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? Please leave your comments below.

Jeremy Phillips does not own shares of the companies mentioned. Try any of our Foolish newsletter services, free for 30 days. The Motley Fool has a disclosure policy.