Should You Sell Chipotle Right Now?

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

Don't sell on price
Over the past 12 months, Chipotle has risen 178.2% versus an S&P 500 return of 11.3%. Investors in Chipotle 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 Chipotle. For historical context, let's compare Chipotle'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, Chipotle 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 Chipotle's valuation. I'm comparing Chipotle's recent P/E ratio of 45.7 with where it has been over the past five years.

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

Chipotle's P/E is higher than its four-year average, which could indicate the stock is overvalued. A high P/E isn't always a bad sign, because the company's growth prospects may also be increasing alongside the market's valuation. However, it definitely indicates that, on a purely historical basis, Chipotle 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 Chipotle's gross margin over the past five years:

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

Chipotle is having no trouble maintaining its gross margin, which tends to dictate a company's overall profitability. This is solid news; however, Chipotle investors need to keep an eye on this over the coming quarters. If margins begin to drop, you'll want to know why.

Next, let's explore what other investors think about Chipotle. 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 rates 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 in the middle of the road on Chipotle. 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 Chipotle's stock pitch page to see the verbatim reasons behind the ratings.

Here, short interest is at a high 11.7%. This typically indicates that large institutional investors are betting against the stock.

Now, let's study Chipotle's debt situation, with a little help from the debt-to-equity ratio. This metric tells us how much debt the company has taken on, relative to its overall capital structure.

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

Chipotle's minuscule total debt is around its five-year average. When we take into account increasing total equity over the same time, 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.  Chipotle is below this level, at 0.5%.

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If Chipotle 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 latest filing, Chipotle has a current ratio of 3.34. 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 Chipotle 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 Chipotle.

The recap

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

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