Should you sell MedcoHealth Solutions (NYSE: MHS) today?

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

Don't sell on price
Over the past 12 months, MedcoHealth Solutions is down 3.6% versus an S&P 500 return of 11.3%. Investors in MedcoHealth Solutions 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 MedcoHealth Solutions investing thesis. For historical context, let's compare MedcoHealth Solutions'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:

Company

Recent Price

52-Week High

5-Year High

MedcoHealth Solutions

$52.06

$66.94

$66.94

Johnson & Johnson (NYSE: JNJ)

$61.96

$66.20

$72.80

CVS Caremark (NYSE: CVS)

$31.47

$38.27

$44.30

Unitedhealth Group (NYSE: UNH)

$35.11

$36.07

$64.60

Source: Capital IQ, a division of Standard & Poor's. As of Sept. 30.

As you can see, MedcoHealth Solutions 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 MedcoHealth's valuation. I'm comparing MedcoHealth's recent P/E ratio of 18.2 to where it's been over the past five years.



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

MedcoHealth Solutions'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, MedcoHealth Solutions looks cheap.

Now, 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 MedcoHealth Solutions's gross margin over the past five years:



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

MedcoHealth Solutions has been able to grow its gross margin, which tends to dictate a company's overall profitability. This is great news; however, MedcoHealth Solutions 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 MedcoHealth Solutions. 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.

Company

CAPS Rating (out of 5)

Short Interest (% of Float)

MedcoHealth Solutions

4

1.8%

Johnson & Johnson

5

1.1%

CVS Caremark

4

1%

Unitedhealth Group

4

1.2% 

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

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

Here, short interest is at a mere 1.8%. This typically indicates few large institutional investors are betting against the stock.

Now, let's study MedcoHealth Solutions'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.

MedcoHealth Solutions has been taking on some additional 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 increase, as seen in the above chart. Based on the trend alone, that's a bad sign. I consider a debt-to-equity ratio below 50% to be healthy, though it varies by industry.  MedcoHealth Solutions is currently above this level, at 81.7%.

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If MedcoHealth Solutions 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, MedcoHealth Solutions has a current ratio of 1.07. MedcoHealth Solutions could cover its liabilities, but it's still below a healthy level of 1.5.

Finally, it's highly beneficial to determine whether MedcoHealth Solutions 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 MedcoHealth Solutions

The final recap


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

Remember to add MedcoHealth Solutions 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.

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.

Jeremy Phillips does not own shares of the companies mentioned. UnitedHealth Group is a Motley Fool Inside Value pick. MedcoHealth Solutions and UnitedHealth Group are Motley Fool Stock Advisor recommendations. Johnson & Johnson is a Motley Fool Income Investor choice. Motley Fool Optionshas recommended diagonal call positions on Johnson & Johnson and UnitedHealth Group. The Fool owns shares of Johnson & Johnson and UnitedHealth Group. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.