Read This Before You Think About Selling Cree

Should you sell Cree (NAS: CREE) 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 and the recent volatility throughout early August. In this series, 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 Cree, ready to evaluate its price, valuation, margins, and liquidity. Let's get started!

Don't sell on price
Over the past 12 months, Cree is down 35.2% versus an S&P 500 return of 9.1%. Investors in Cree 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 Cree investing thesis. For historical context, let's compare Cree'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, Cree is well off 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 Cree's valuation. I'm comparing Cree's recent P/E ratio of 27.6 to where it's been over the past five years.

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

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

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

Cree has been able to grow its gross margin, which tends to dictate a company's overall profitability. This is great news; however, Cree 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 Cree. 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 180,000-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 in the middle of the road on Cree. 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 Cree's stock pitch page to see the verbatim reasons behind the ratings.

Here, short interest is at a high 15.2%. This typically indicates that large institutional investors are betting against the stock.

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If Cree 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, Cree has a current ratio of 10.40. 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 Cree 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 Cree.

The final recap

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

In order to do that, I strongly recommend clicking here to add Cree to My Watchlist to help you keep track of all of our ongoing coverage of the company.

At the time thisarticle was published Jeremy Phillips does not own shares of the companies mentioned. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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