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

Don't sell on price
Over the past 12 months, Lam Research has risen 29.7% versus an S&P 500 return of 13.7%. Investors in Lam Research 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 Lam Research. For historical context, let's compare Lam Research'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

Lam Research $50.40 $52.91 $60.80
Applied Materials (Nasdaq: AMAT) $14.24 $14.57 $23.00
Varian Semiconductor Equipment Associates (Nasdaq: VSEA) $41.59 $42.17 $58.20
Teradyne (NYSE: TER) $14.02 $14.44 $18.50

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

Lam Research is basically at its 52-week high. This means we need to dig into the valuation to ensure that these new 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's facing tough times. Here is Lam Research's gross margin over the past five years:

Lrcxgrossmargins

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

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

Next, let's explore what other investors think about Lam Research. 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)

Lam Research 3 2.9
Applied Materials 5 1.6
Varian Semiconductor Equipment Associates 5 2.6
Teradyne 4 12.6

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

The Fool community is in the middle of the road on Lam Research. 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 Lam Research's stock pitch page to see the verbatim reasons behind the ratings.

Here, short interest is at a mere 2.9%. This typically indicates few large institutional investors are betting against the stock.

Now, let's study Lam Research'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.

Lrcxtotaldebttoequity

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

Lam Research's total debt is around its five-year average, even though it's significantly less than in 2006. 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.  Lam Research is currently below this level, at 1.1%.

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If Lam Research 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, Lam Research has a current ratio of 3.13. 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 Lam Research 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 Lam Research.

The final recap

Lrcxsellingrecap

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

Remember to add Lam Research 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, be 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. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insightsmakes us better investors. The Motley Fool has a disclosure policy.