Is Alcoa a Buffett Stock?

As the world's third-richest person and most celebrated investor, Warren Buffett attracts a lot of attention. Thousands try to glean what they can from his thinking processes and track his investments.

We can't know for sure whether Buffett is about to buy Alcoa (NYSE: AA  ) -- he hasn't specifically mentioned anything about it to me -- but we can discover whether it's the sort of stock that might interest him. Answering that question could also reveal whether it's a stock that should interest us.

In his most recent 10-K, Buffett lays out the qualities he looks for in an investment. In addition to adequate size, proven management, and a reasonable valuation, he demands:

  1. Consistent earnings power.
  2. Good returns on equity with limited or no debt.
  3. Management in place.
  4. Simple, non-techno-mumbo-jumbo businesses.

Does Alcoa meet Buffett's standards?

1. Earnings power
Buffett is famous for betting on a sure thing. For that reason, he likes to see companies with demonstrated earnings stability.

Let's examine Alcoa's earnings and free cash flow:

    

Alcoa was greatly affected by the economic downturn, but the company now seems to be regaining its footing somewhat.

2. Return on equity and debt
Return on equity is a great metric for measuring both management's effectiveness and the strength of a company's competitive advantage or disadvantage -- a classic Buffett consideration. When considering return on equity, it's important to make sure a company doesn't have an enormous debt burden, because that will skew your calculations and make the company look much more efficient than it actually is.

Since competitive strength is a comparison between peers, and various industries have different levels of profitability and require different levels of debt, it helps to use an industry context.

Company

Debt-to-Equity

Return on Equity (LTM)

Return on Equity (5-Year Average)

Alcoa 48% 7% 7%
Reliance Steel & Aluminum (NYSE: RS  ) 37% 9% 16%
Freeport-McMoRan (NYSE: FCX  ) 21% 48% 21%
United States Steel (NYSE: X  ) 93% (4%) 11%

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

Alcoa tends to generate a moderately low return on equity while employing moderate amounts of debt.

3. Management
CEO Klaus-Christian Kleinfeld has been at the job since 2008. Before coming to Alcoa in 2007, he worked at Siemens, where he also served as its CEO. He's been the boards of Alcoa, Siemens, and Citigroup, as well as two powerful business lobbies, the Chamber of Commerce and Business Roundtable.

4. Business
Aluminum production isn't particularly susceptible to wholesale technological disruption, though it's obviously subject to economic cyclicality.

The Foolish conclusion
Whether or not Buffett would buy shares of Alcoa, we've learned that, while it operates in a fairly straightforward industry, it doesn't particularly exhibit the characteristics of a quintessential Buffett investment: consistent earnings and high returns on equity with limited debt.

If you'd like to stay up to speed on the top news and analysis on Alcoa or any other stock, simply add it to your stock watchlist. If you don't have one yet, you can create a watchlist of your favorite stocks.

Ilan Moscovitz doesn't own shares of any company mentioned. You can follow him on Twitter @TMFDada. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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