Should You Sell Cliffs Natural Resources Today?

Should you sell Cliffs Natural Resources (NYSE: CLF) 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 Cliffs Natural Resources, ready to evaluate its price, valuation, margins, and liquidity. Let's get started!

Don't sell on price
Over the past 12 months, Cliffs Natural Resources has risen 69.8% versus an S&P 500 return of 11.3%. Investors in Cliffs Natural Resources 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 Cliffs Natural Resources. For historical context, let's compare Cliffs Natural Resources'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:

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

As you can see, Cliffs Natural Resources 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 Cliffs Natural Resources' valuation. I'm comparing Cliffs Natural Resources' recent P/E ratio of 17.5 to where it's been over the past five years.

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

Cliffs Natural Resources' P/E is higher than its five-year average, which could indicate the stock is overvalued. A high P/E isn't always a bad sign, since the company's growth prospects may also be increasing alongside the market's valuation. However, it definitely indicates that, on a purely historical basis, Cliffs Natural Resources looks expensive.

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 is facing tough times. Here is Cliffs Natural Resources' gross margin over the past five years:

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

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

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

The Fool community is rather bullish on Cliffs Natural Resources. 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 Cliffs Natural Resources' stock pitch page to see the verbatim reasons behind the ratings.

Here, short interest is at a mere 4.6%. This typically indicates few large institutional investors are betting against the stock.

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If Cliffs Natural Resources 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, Cliffs Natural Resources has a current ratio of 2.28. 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 Cliffs Natural Resources 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 Cliffs Natural Resources

The final recap

Cliffs Natural Resources has failed 1 of the quick tests that would make it a sell. This is great, but does it mean you should hold your Cliffs Natural Resources shares? Not necessarily. Just keep your eye on these trends over the coming quarters.

Remember to add Cliffs Natural Resources 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 over $100,000 in gains through wrong-headed selling.