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Has Alcoa Become the Perfect Stock?

http://www.fool.com/investing/general/2011/10/25/has-alcoa-become-the-perfect-stock.aspx

Dan Caplinger
October 25, 2011

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%

(3.3%)

Fail

 

1-year revenue growth > 12%

18.4%

Pass

Margins

Gross margin > 35%

19.6%

Fail

 

Net margin > 15%

4.3%

Fail

Balance sheet

Debt to equity < 50%

50.9%

Fail

 

Current ratio > 1.3

1.36

Pass

Opportunities

Return on equity > 15%

7.2%

Fail

Valuation

Normalized P/E < 20

11.09

Pass

Dividends

Current yield > 2%

1.1%

Fail

 

5-year dividend growth > 10%

(27.5%)

Fail

       
 

Total score

 

3 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Even with just three points, Alcoa has improved from last year, when it only managed a score of one. A return to profitability and impressive revenue growth in the past year account for the improvement, but the aluminum producer still has a long way to go.

Alcoa has been a member of the Dow Jones Industrials (INDEX: ^DJI) for more than 50 years now. It still represents part of the industrial core of the stock market.

But all is still not right with Alcoa. When it kicked off earnings season a couple weeks ago, the company saw much-improved results from the year-ago quarter but saw sequential declines from earlier this year. More direly, CEO Klaus Kleinfeld said that lower prices would likely lead to slower growth for the rest of the year. Moreover, trends like Boeing's (NYSE: BA  ) use of