Should You Sell CVS Caremark Right Now?

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

Don't sell on price
Over the past 12 months, CVS is down 16.4% versus an S&P 500 return of 11.3%. Investors in CVS 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 CVS investing thesis. For historical context, let's compare CVS'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, CVS 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 CVS's valuation. I'm comparing CVS's recent P/E ratio of 11.5 to where it's been over the past five years.

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

CVS'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, CVS 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 CVS's gross margin over the past five years:

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

CVS is clearly having issues maintaining its gross margin, which tends to dictate a company's overall profitability. CVS investors need to keep an eye on this troubling trend over the coming quarters.

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

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

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

Here, short interest is at a mere 1%. This typically indicates few large institutional investors are betting against the stock.

Now, let's study CVS'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.

CVS 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 decrease, as seen in the above chart. Based on the trend alone, that's a good sign. I consider a debt-to-equity ratio below 50% to be healthy, though it varies by industry.  CVS is currently below this level, at 33.3%.

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If CVS had to convert its current assets to cash in one year, how many times over could the company cover its current liabilities? As of the last filing, CVS has a current ratio of 1.51. This is a healthy sign. I like to see companies with current ratios equal to or greater than 1.5.

Finally, it's highly beneficial to determine whether CVS 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 CVS.

The final recap

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

Remember to add CVS 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.