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

Don't sell on price
Over the past 12 months, Otter Tail is down 11.9% versus an S&P 500 return of 11.3%. Investors in Otter Tail 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 Otter Tail investing thesis. For historical context, let's compare Otter Tail's recent price to its 52-week and five-year highs. I've also included a few other businesses that either compete with Otter Tail or operate as utilities and share similar traits with the company:

Company

Recent Price

52-Week High

5-Year High

Otter Tail $20.39 $25.39 $46.20
DPL (NYSE: DPL) $26.13 $28.86 $32.70
Hawaiian Electric Industries (NYSE: HE) $22.54 $24.99 $29.80
Cleco (NYSE: CNL) $29.62 $30.00 $30.00

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

As you can see, Otter Tail 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 Otter Tail's valuation. I'm comparing Otter Tail's recent P/E ratio of 85.0 to where it's been over the past five years.



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

Otter Tail's 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. In Otter Tail's case, while net income has been declining recently, it took at hit from a $20 million asset writedown. However, on a purely historical basis, Otter Tail 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's facing tough times. Here is Otter Tail's gross margin over the past five years:



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

Otter Tail is having no trouble maintaining its gross margin, which tends to dictate a company's overall profitability. This is solid news; however, Otter Tail 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 Otter Tail. 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 (Float)

Otter Tail 5 6.3%
DPL 4 3.8%
Hawaiian Electric Industries 4 4.2%
Cleco 5 6.7%

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

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

Here, short interest is at a high 6.3%. This typically indicates that large institutional investors are betting against the stock.

Now, let's study Otter Tail'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.

Otter Tail 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 increase, as seen in the above chart. Based on the trend alone, that's a bad sign. I consider a debt-to-equity ratio below 50% to be healthy, though it varies by industry. Otter Tail is currently above this level, at 76.9%.

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If Otter Tail 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, Otter Tail has a current ratio of 1.62. 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 Otter Tail 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 Otter Tail.

The final recap


Otter Tail has failed 3 of the quick tests that would make it a sell. Does it mean you should sell your Otter Tail shares today solely because of this? Not necessarily, but keep your eye on these trends over the coming quarters.

Remember to add Otter Tail to My Watchlist to help you keep track of all our coverage of the company on Fool.com.

What companies would you like me to cover next in this series? Please leave your comments below.

Jeremy Phillips does not own shares of the companies mentioned.

Otter Tail is a Motley Fool Hidden Gems pick. 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 Motley Fool has a disclosure policy.