Is Alcoa Still A Buy, Or Simply A Lost Opportunity?

 |  About: Alcoa, Inc. (AA), Includes: F, FOIL, JJU, XME
by: Paul Boland

On Monday, Alcoa (NYSE:AA) reached a 52 week high as noted by Zack's Investment Research. After a year-to-date return of 24.85%, Zack's continues to mark AA as a 'buy,' while The Street marks AA as a 'hold' in their analysis released on Friday (December 27th). Alcoa seems to be considered quite positively within the social media community, at the moment, most analysts and investors are tweeting positively about this stock. However, in a very real sense the "cat is out of the bag" on AA after the strong increase in price during 2013, prompting two questions:

A) How should an investor have known to buy AA earlier in the year?

B) Is AA still a strong 'buy' for 2014, or has all the profit been sucked out of it?

I always try to use a very simple three step analysis during my initial consideration of a position. From these three steps, we can determine why AA was such a good buy months in the past, and what these same simple metrics can tell us about its current value proposition to the investor.

1. P/E Ratio - Investors familiar with AA will probably not understand why the P/E Ratio could be a good metric for consideration of Alcoa. The P/E Ratio currently stands at roughly 38.49 (Price = $10.63 divided by 12 months of trailing EPS = $0.2762). 38.49 is not a very good P/E Ratio for a stock. However, if we take the advice given by Graham and Dodd over seventy years ago, and take into consideration the last 10 years of data for earnings and adjust it for inflation (per Shiller) then we might have a better valuation metric or modified P/E Ratio. This is considered to be the Cyclically Adjusted P/E Ratio or CAPE Ratio. If we do the calculation (or simply use the calculator) we come to a value of 9.32. If we speculate that a good price for the stock would lead to a Cyclically Adjusted P/E Ratio of roughly 15 (as is suggested by Graham) we can quickly see that the price of the stock would then be projected at roughly $17.

Some useful charts with respect to this - here is the EPS data for every quarter for the last 25 years:

(click to enlarge)Earnings Per Share over 25 YearsClick to enlarge

And the most recent quarterly earnings per share data (and as a note special items are included as deductions within both third quarters):

2. P/B Ratio - Most value investors from the school of Graham, or Buffett and Schloss utilize this metric for stock valuation. I personally incorporate both CAPE and P/B since the earnings data gives some idea of operations currently ongoing while the P/B ratio gives us a strong snapshot of exactly what we are buying currently. The P/B Ratio for AA is currently at 0.8882 as of December 31st. So for every dollar invested into AA a shareholder could expect $1.13 back if the company were to go bankrupt tomorrow which would seem to indicate that the price ought to be closer to $11.96 where the P/B Ratio would equal 1.00. This might indicate that AA is currently a strong 'buy'. However, based on this same analysis one should have really purchased AA back at the end of June when the P/B Ratio was close to 0.65 and the price was just short of $8.00. So, based on the P/B Ratio, there is probably still some value one can squeeze out, but this is fast approaching zero.

3. Qualitative Factors - Since metrics are based on either current data or only representative of backward-looking information, I try to consider other items that might indicate the emergence or continuance of a strong competitive advantage. When revenue for a given company is largely dependent upon the price of raw materials (either inputs or outputs), there is always a fundamental difficulty (US Steel comes to mind). Aluminum rose since the recession to a 5 year high back in April 2011 when the price per pound was roughly $1.20. However, since that time aluminum's price per pound has fallen to roughly $0.80 currently. This is not a good thing; however in Alcoa's case this might prove to be an advantage with respect to its competitors. Alcoa is uniquely situated in comparison to other companies within the aluminum mining and metals sector. This is because of their great strides in alloy development for the military and light vehicle construction. Ford (NYSE:F) is expected to release their new version of the F-150 later this January with a mostly Aluminum design and Alcoa will likely be a key supplier (as Ford has used Alcoa for the initial design phase). In addition to the new Ford truck based off of Alcoa as the supplier, we also can see from their recent press releases that they have made great strides in the aerospace industry. Based on all of this, Alcoa should be uniquely positioned to squeeze a greater margin from higher quality alloys than its competitors during 2014.

Is Alcoa a good buy? AA is probably a strong 'buy' currently. However, AA is not as good a buy as it was during the summer months of 2013 and may be quickly approach the 'no man's land' zone. There were some strong indicators during the summer that should have caused the intelligent investor to take a stake in the company, however there are now better qualitative factors pointing towards the future that seem to indicate that Alcoa is a strong buy. During the summer there would have been a greater risk with respect to this stock since the purchase decision would mostly be predicated on metrics based on backwards looking data. Now this risk is somewhat mitigated by the latest quarter's positive information, the increase over the previous year's data, and the positive qualitative data/information with respect to Ford and the Aerospace industry. In conclusion, AA is most likely a strong purchase currently, but would have been a fantastic purchase during the summer.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AA, over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.