Should you sell Best Buy (NYSE: BBY) today?

The decision to sell a stock you've researched and followed for months or years is never easy. But 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 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 Best Buy, ready to evaluate its price, valuation, margins, and liquidity. Let's get started!

Don't sell on price
Over the past 12 months, Best Buy has risen by 10.3% versus an S&P 500 return of 11.3%.  It's likely that Best Buy investors are merely satisfied with their market-matching returns, but is now the time to cut and run? Not necessarily. Short-term mild underperformance alone is not a sell sign. The market may be missing the critical element of your Best Buy investing thesis. For historical context, let's compare Best Buy's recent price with its 52-week and five-year highs. I've also included a few other businesses in the same industry or a related one.

Company

Recent Price

52-Week High

5-Year High

Best Buy $40.83 $48.83 $100.70
Amazon.com (Nasdaq: AMZN) $157.06 $161.78 $161.80
Target (NYSE: TGT) $53.44 $58.52 $70.80
Wal-Mart Stores (NYSE: WMT) $53.52 $56.27 $63.90

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

As you can see, Best Buy 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 up, we'll get a rough idea of Best Buy's valuation. I'm comparing Best Buy's recent P/E ratio of 12.2 with where it's been over the past five years.  


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

Best Buy's P/E is lower than its five-year average, a possible indication that 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. But it does indicate that, on a purely historical basis, Best Buy looks cheap.

Now let's look at the gross-margin 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 faces tough times. Here's a look at Best Buy's gross margin over the past five years.


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

Although it looks choppy, Best Buy is having no trouble maintaining its gross margin, which tends to dictate a company's overall profitability. This is solid news; however, Best Buy investors need to keep an eye on this metric over the coming quarters. If margins begin to dip, you'll want to know why.

Next, let's explore what other investors think about Best Buy. 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 portion of our research, 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 rates the stock, and the latter shows what proportion of investors is betting that the stock will fall. I'm including other peer companies once again for context.

Company

CAPS Rating (out of 5)

Short Interest (Float)

Best Buy 3 5.7
Amazon.com 2 4.7
Target 3 1.7
Wal-Mart Stores 3 1.4

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

The Fool community is in the middle of the road on Best Buy. We typically like to see our stocks rated at four or five stars. Anything below that level is a less-than-bullish indicator. I highly recommend that you visit Best Buy's stock-pitch page to see the verbatim reasons behind the ratings.

Here, short interest is at a high 5.7%. A number like this typically indicates that large institutional investors are betting against the stock.

Now let's study Best Buy'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.

Best Buy has taken on some additional debt over the past five years. With total equity basically unchanged over the same time period, debt-to-equity has consequently increased, as the chart shows. Based on the trend alone, that's a bad sign. I consider a debt-to-equity ratio below 50% to be healthy, though the number can vary by industry. Best Buy is currently below this level, at 22.7%.

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If Best Buy had to convert its current assets to cash in one year, how many times over could the company cover its liabilities? As of the last filing, Best Buy has a current ratio of 1.18. Best Buy could cover its liabilities, but it's still below a healthy level of 1.5.

Finally, it's highly beneficial to determine whether Best Buy 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 adding Best Buy.

The final recap


Best Buy has failed four of the quick tests that would make it a sell. Does that mean you should sell your Best Buy shares today? Not necessarily, but keep your eye on these trends over the coming quarters.

Remember to add Best Buy 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.

Jeremy Phillips owns no shares of the companies mentioned. Best Buy and Wal-Mart are Motley Fool Inside Value selections. Amazon.com and Best Buy are Motley Fool Stock Advisor recommendations. Motley Fool Options has recommended buying calls on Best Buy. The Fool owns shares of Best Buy and Wal-Mart. Try any of our Foolish newsletter services free for 30 days.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.