Time to Sell LDK Solar?

Should you sell LDK Solar (NYSE: LDK) today?

The decision to sell a stock you've researched and followed for months or years is never easy. But 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 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 LDK Solar, ready to evaluate its price, valuation, margins, and liquidity. Let's get started!

Don't sell on price
Over the past 12 months, LDK Solar is down 13.3% versus an S&P 500 return of 9.1%. Investors in LDK Solar 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 LDK Solar investing thesis. For historical context, let’s compare LDK Solar's recent price with its 52-week and five-year highs. I've also included a few other businesses in the same industry or a related one.

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

As you can see, LDK Solar 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 LDK Solar's gross margin over the past five years.

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

Despite a recent bounce, LDK Solar has clearly had issues maintaining its gross margin, which tends to dictate a company's overall profitability. LDK Solar investors need to keep an eye on this troubling trend over the coming quarters.

Next, let's explore what other investors think about LDK Solar. 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 portion of our research, 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 rates the stock, and the latter shows what proportion of investors is 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 in the middle of the road on LDK Solar. We typically like to see our stocks rated at four or five stars. Anything below that level is a less-than-bullish indicator. I highly recommend you visit LDK Solar's stock-pitch page to see the verbatim reasons behind the ratings.

Here, short interest is at a high 56.3%. A number like this typically indicates that large institutional investors are betting against the stock.

Now let's study LDK Solar'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.

LDK Solar has been taking on some additional debt over the past five years. Even with increasing total equity over the same time period, debt-to-equity has increased. Based on the trend alone, that's a bad sign. I consider a debt-to-equity ratio below 50% to be healthy, though the number varies by industry. LDK Solar is currently above this level, at 215.6%.

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If LDK Solar had to convert its current assets to cash in one year, how many times over could it cover its current liabilities? As of the last filing, LDK Solar has a current ratio of 0.68. This is a bad sign for LDK Solar. The company's current liabilities are greater than its current assets, which means it could have liquidity issues in the short term.

Finally, it's highly beneficial to determine whether LDK Solar 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 adding LDK Solar.

The final recap

LDK Solar has failed five of the quick tests that would make it a sell. Does that mean you should sell your LDK Solar shares today? Not necessarily, but keep your eye on these trends over the coming quarters.

To do that, I strongly recommend adding LDK Solar to My Watchlist  to help you keep track of all of our ongoing coverage of the company.