Should you sell Nuance Communications (Nasdaq: NUAN) 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 Nuance Communications, ready to evaluate its price, valuation, margins, and liquidity. Let's get started!

Don't sell on price
Over the past 12 months, Nuance Communications shares have risen 10.8% versus an S&P 500 return of 11.3%. Investors in Nuance Communications 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 Nuance Communications investing thesis. For historical context, let's compare the company's recent price to its 52-week and five-year highs. I've also included a few other businesses that focus on software and are often lumped with Nuance Communications as growth company peers:

Company

Recent Price

52-Week High

5-Year High

Nuance Communications $15.64 $18.55 $22.60
salesforce.com (NYSE: CRM) $111.80 $123.77 $123.77
Citrix Systems (Nasdaq: CTXS) $68.24 $71.93 $71.93
Tibco Software (Nasdaq: TIBX) $17.74 $18.95 $18.95

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

As you can see, Nuance Communications 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 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 Nuance Communications' gross margin over the past five years:


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

Nuance Communications has had some trouble maintaining its gross margin, which tends to dictate a company's overall profitability. However, the decline seems to have stabilized in the most recent years. This is solid news, but Nuance Communications investors need to keep an eye on this over the coming quarters. If margins begin to drop again, you'll want to know why.

Next, let's explore what other investors think about Nuance Communications. 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

Short Interest (% of Float)

Nuance Communications **** 8.7
salesforce.com * 9.0
Citrix Systems ** 3.5
Tibco Software *** 6.9

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

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

Here, short interest is at a high 8.7%. This typically indicates that large institutional investors are betting against the stock.

Now, let's study Nuance Communications' 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.

Nuance Communications has been taking on some additional 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 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. Nuance Communications is below this level, at 39.2%.

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If Nuance Communications had to convert its current assets to cash in one year, how many times over could the company cover its liabilities? As of the latest filing, the company has a current ratio of 2.18. This is a healthy sign. I like to see companies with current ratios greater than 1.5.

Finally, it's highly beneficial to determine whether Nuance Communications 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 Nuance Communications.

The recap


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

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

If you haven't had a chance yet, but sure to read this article detailing how I missed out on more than $100,000 in gains through wrong-headed selling.

Jeremy Phillips does not own shares of the companies mentioned.

salesforce.com is a Motley Fool Rule Breakers selection. Nuance Communications is a Motley Fool Stock Advisor recommendation and a Motley Fool Hidden Gems pick. 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 Fool has a disclosure policy.