Should you sell El Paso (NYSE: EP) 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 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 El Paso, ready to evaluate its price, valuation, margins, and liquidity. Let's get started!

Don't sell on price
Over the past 12 months, El Paso has risen 18% versus an S&P 500 return of 11.3%. Investors in El Paso have every reason to be proud of their returns, but is it time to take some off the top? Not necessarily. Short-term outperformance alone is not a sell sign. The market may be just beginning to realize the true, intrinsic value of El Paso. For historical context, let's compare El Paso'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

El Paso $13.16 $13.45 $22.50
EOG Resources (NYSE: EOG) $100.04 $114.95 $145.00
Kinder Morgan Energy Partners (NYSE: KMP) $70.95 $71.16 $71.20
Spectra Energy (NYSE: SE) $23.60 $23.86 $30.00

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

El Paso is basically at its 52-week high. This means we need to dig into the valuation to ensure that these previously untested highs are justified.

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 is facing tough times. Here is El Paso's gross margin over the past five years:



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

El Paso has been able to grow its gross margin, which tends to dictate a company's overall profitability. This is great news; however, El Paso investors need to keep an eye on this over the coming quarters. If margins begin to drop, you'll want to know why.

Next, let's explore what other investors think about El Paso. 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)

El Paso ***** 2.3
EOG Resources **** 3.1
Kinder Morgan Energy Partners ***** 2.0
Spectra Energy ***** 1.5

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

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

Here, short interest is at a mere 2.3%. This typically indicates few large institutional investors are betting against the stock.

Now, let's study El Paso'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.

El Paso has reduced its debt slightly over the past five years. When we take into account essentially unchanged 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 below 50% to be healthy, though it varies by industry. El Paso is above this level, at 370%.

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If El Paso 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, El Paso has a current ratio of 0.70. This is a bad sign. The company's liabilities are greater than its assets, which means it could have liquidity issues in the short term.

Finally, it's highly beneficial to determine whether El Paso 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 El Paso.

The recap


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

Remember to add El Paso 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.

Spectra Energy is a Motley Fool Income Investor selection. 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.