Has Alcoa Become the Perfect Stock?

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Alcoa (NYSE: AA  ) fits the bill.

The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
  • Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
  • Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
  • Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Alcoa.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-Year Annual Revenue Growth > 15%

(5.3%)

Fail

 

1-Year Revenue Growth > 12%

(3.3%)

Fail

Margins

Gross Margin > 35%

12.8%

Fail

 

Net Margin > 15%

(1%)

Fail

Balance Sheet

Debt to Equity < 50%

56.5%

Fail

 

Current Ratio > 1.3

1.19

Fail

Opportunities

Return on Equity > 15%

(1.5%)

Fail

Valuation

Normalized P/E < 20

NM

NM

Dividends

Current Yield > 2%

1.3%

Fail

 

5-Year Dividend Growth > 10%

(28.9%)

Fail

       
 

Total Score

 

0 out of 9

Source: S&P Capital IQ. NM = not meaningful due to negative earnings. Total score = number of passes.

Since we looked at Alcoa last year, the company has lost all three of its points, doing even worse than the one point it earned in 2010. Revenue and earnings have plunged, and the stock's 15% drop over the past year hasn't done investors any favors either.

Over the past year, the big news story for Alcoa has been the changing economic situation in China. Although Europe and the U.S. certainly have an impact on the aluminum maker's fortunes, China's long-term growth story has driven growth throughout the materials sector. When China's growth slowed to 7.6% during the second quarter, copper king Freeport-McMoRan (NYSE: FCX  ) , molybdenum producer Thompson Creek Metals (NYSE: TC  ) , and Alcoa all found themselves facing problems that they've largely been able to avoid throughout China's strong growth phase.

An even larger long-term threat to Alcoa exists as manufacturers make design changes that use less of the lightweight metal. With General Electric (NYSE: GE  ) and Boeing (NYSE: BA  ) looking to alternatives like ceramics and carbon fiber as low-weight alternatives to aluminum, Alcoa could find itself having to defend itself not just from traditional competitors but also from new entrants to these once-niche materials.

Alcoa got a brief bounce based on China's decision to implement a $150 billion infrastructure stimulus program. But with the company giving weak future guidance in its quarterly earnings report this month, Alcoa isn't inspiring confidence among investors right now.

For Alcoa to improve, it simply has to find ways to make more money regardless of weak economic conditions. If it can't, then Alcoa could well spend quite a while near the bottom of our 10-point scale.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

Alcoa may not be firing on all cylinders right now, but General Electric has certainly fought back from its own crisis of confidence. The financial meltdown struck a blow, but management took advantage of the market's dip to make strategic bets in energy. If you're a GE investor, you need to understand how these bets could drive this company to become the world's infrastructure leader. Find out whether General Electric is a buy in our latest premium report on the company, in which our industrials analyst breaks down GE's multiple businesses. You'll find reasons to buy or sell GE, and you'll receive continuing updates as major events unfold during the year. To get started, click here now.

Click here to add Alcoa to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Fool contributor Dan Caplinger has no positions in the stocks mentioned above. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold and General Electric. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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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