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Here is a look at how Alcoa Inc. (NYSE:AA) fares in ModernGraham's opinion, based on an updated and modernized version of Benjamin Graham's requirements of defensive and enterprising investors from The Intelligent Investor:

Defensive and Enterprising Investor Tests (What is the significance of these tests, and what is PEmg ratio?):

Defensive Investor - must pass at least 6 of the following 7 tests: Score = 3/7

  1. Adequate Size of Enterprise - market capitalization of at least $2 billion - PASS
  2. Sufficiently Strong Financial Condition - current ratio greater than 2 - FAIL
  3. Earnings Stability - positive earnings per share for at least 10 straight years - FAIL
  4. Dividend Record - has paid a dividend for at least 10 straight years - PASS
  5. Earnings Growth - earnings per share has increased by at least 1/3 over the last 10 years using 3 year averages at beginning and end of period - FAIL
  6. Moderate PEmg ratio - PEmg is less than 20 - FAIL
  7. Moderate Price to Assets - PB ratio is less than 2.5 or PB x PEmg is less than 50 - PASS

Enterprising Investor - must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 1/5

  1. Sufficiently Strong Financial Condition, Part 1 - current ratio greater than 1.5 - FAIL
  2. Sufficiently Strong Financial Condition, Part 2 - Debt to Net Current Assets ratio less than 1.1 - FAIL
  3. Earnings Stability - positive earnings per share for at least 5 years - FAIL
  4. Dividend Record - currently pays a dividend - PASS
  5. Earnings growth - EPSmg greater than 5 years ago - FAIL

Valuation Summary (Explanation of the ModernGraham Valuation Model)

Key Data:

MG Value$0.00 ** See conclusion.
MG OpinionOvervalued
Value Based on 3% Growth$1.94
Value Based on 0% Growth$1.14
Market Implied Growth Rate35.04%
Net Current Asset Value (NCAV)-$17.13
PEmg78.58
Current Ratio1.17
PB Ratio0.88

Balance Sheet - 9/30/2013

Current Assets$7,049,000,000
Current Liabilities$6,040,000,000
Total Debt$7,630,000,000
Total Assets$38,229,000,000
Intangible Assets$5,144,000,000
Total Liabilities$25,373,000,000
Outstanding Shares1,069,600,000

Earnings Per Share

2013 (estimate)$0.04
2012$0.18
2011$0.55
2010$0.25
2009-$1.06
2008$0.28
2007$2.95
2006$2.47
2005$1.40
2004$1.60
2003$1.20
2002$0.61

Earnings Per Share - ModernGraham

2013 (estimate)$0.13
2012$0.13
2011$0.27
2010$0.41
2009$0.73
2008$1.67

Conclusion:

Alcoa Inc. is a company that has seen better days and currently has a very poor valuation. The company passes only three of the tests of the Defensive Investor and only one of the requirements of the Enterprising Investor. The company has a poor current ratio, lacks earnings stability, has demonstrated no growth in earnings, and is trading at a high PEmg ratio. Investors seeking to use a value investing approach as is used by ModernGraham would do better by looking at some companies that pass the requirements set forth by Benjamin Graham.

From a valuation perspective, Alcoa's EPSmg (normalized earnings) have gone from $1.67 in 2008 to an estimated $0.13 for 2013. This shrinking of earnings leads the ModernGraham valuation model to return an intrinsic value of $0. There may be some value, but any method of calculating value that does not rely solely on the fundamentals of the company includes some level of speculation. Intelligent Investors avoid speculation as much as possible, so they may be better served with a different company at this time.

What do you think? Do you agree that Alcoa Inc. is overvalued? What would be your assessment? Is the company not suitable for Defensive Investors or Enterprising Investors?

Disclosure: The author did not hold a position in Alcoa Inc. (AA) at the time of publication and had no intention of changing that position within the next 72 hours.

Source: ModernGraham Valuation Of Alcoa Inc.