Analyst Rates Alcoa Inc a "Buy." Should You Care?

According to Sterne Agee, the stock tickered "AA" will be a AAA investment.

Mar 14, 2014 at 6:00PM

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." So you might think we'd be the last people to give virtual ink to such "news." And we would be -- if that were all we were doing.

But in this article, we won't simply tell you what the analysts said. We'll also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our supercomputer tool for rating stocks and analysts alike. With CAPS, we track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

And speaking of the best...
There's great news for Alcoa (NYSE:AA) shareholders today, as analysts at investment bank Sterne Agee initiate coverage of the stock with a new "buy" rating and a $15 price target. Assuming the analyst is right, this suggests the stock could return a 27% profit over the course of the next 12 months -- and pay a 1% dividend yield to boot.

Across the aluminum industry, enthusiasm is mounting for Ford's (NYSE:F) decision to begin building aluminum-body pickup trucks in 2015. Word has it that General Motors (NYSE:GM) intends to copycat the move by 2018. Result: Within just a few years, both of the world's best-selling full-size pickup trucks will be consuming significant amounts of aluminum -- boosting the fortunes of aluminum makers like Alcoa.

But is that reason enough to buy the stock?

Let's go to the tape
Investors who choose to follow Sterne Agee's advice on Alcoa may find themselves in good company -- or they may not.

Here at Motley Fool CAPS, we've been tracking the performance of this banker's stock picks for close to eight straight years now. What we've discovered is that, over the course of making nearly 400 buy/sell calls, Sterne has racked up a record of outstanding performance relative to its peers. On average, nearly 54% of its recommendations turn out right, and Sterne's currently outperforming more than 96% of the investors tracked on CAPS.

That's the good news. Now, here's the bad news: Sterne has only a very limited track record in sectors related to aluminum. What's more, on average, Sterne gets only about 25% of its "Metals and Mining" industry picks correct:

 

Sterne Agee Said

CAPS Says (out of 5 stars possible)

Sterne Agee's Picks Beating (Lagging) S&P By

AMCOL International

Outperform

***

7 points

Coeur Mining

Outperform

***

(77 points)

Newmont Mining

Outperform

***

(81 points)

Gold Resource Corp

Outperform

*

(115 points)

As track records go, this one isn't particularly encouraging. While it's true that Sterne Agee did guess right once on AMCOL (a bentonite, chromite, and leonardite play), one could argue that the analyst actually missed the boat on that one as well. After Sterne closed its position on the stock back in 2012, the stock has actually gained 30%.

Late to the aluminum party
Sterne's arguably coming late to the aluminum party as well, endorsing Alcoa only after the stock has run up 37%, and doubled the S&P 500's gains over the past year. And now that Sterne has arrived, what does it choose to recommend?

An Alcoa stock that just reported a $2.3 billion loss for 2013, and that even when valued on the more forgiving metric of free cash flow, sells for a 33 times multiple to FCF. (Or more. If you factor Alcoa's debt load into the picture, the stock sells for an enterprise value that's 52 times its annual free cash flow.) 

One final thought
These are very high valuations that Alcoa shares trade for today. When you consider that most analysts agree the stock will grow its profits at no more than 7% annually over the next five years, they seem like valuations too steep for any rational investor to pay. Really, the only hope Sterne Agee has of its Alcoa bet paying off is if analysts have underestimated how a switch to aluminum by truck makers might affect aluminum demand -- and profitability.

They certainly might have. But consider: At the same time we see truck makers like Ford and GM moving toward aluminum, plane makers like Boeing (NYSE:BA) and Airbus (NASDAQOTH:EADSY) are shifting away from aluminum -- and toward the use of carbon composites in manufacturing their planes. That could easily counteract the trend of automakers shifting to aluminum. And what happens if, further down the road, the automakers also decide that they need to move to carbon composites to further lighten the load on their vehicles?

Let's just say this trend wouldn't be kind to the aluminum industry -- or to Alcoa shareholders -- and leave it at that. 

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Fool contributor Rich Smith does not own shares of, nor is he short, any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 400 out of more than 140,000 members. The Motley Fool recommends Ford and General Motors. The Motley Fool owns shares of Ford. 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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