Money Matters - Simplified

Is Alcoa a Sell?

 Should you sell Alcoa (NYSE: AA) today? The decision to sell a stock you've researched and followed for months or years is never easy. If you fall in love with your stock holdings, you risk becoming vulnerable to confirmation bias -- listening only to information that supports your theories, and rejecting any contradictions.

 

 In 2004, longtime Fool Bill Mann called confirmation bias one of the most dangerous components of investing. This warning has helped my own personal investing throughout the Great Recession. Now, I want to help you identify potential sell signs on popular stocks within our 4-million-strong Fool.com community.

Today I'm laser-focused on Alcoa, ready to evaluate its price, valuation, margins, and liquidity. Let's get started!

Don't sell on price
Over the past 12 months, Alcoa has risen 1.2% versus an S&P 500 return of 11.3%. Investors in Alcoa are no doubt disappointed with their returns, but is now the time to cut and run? Not necessarily. Short-term underperformance alone is not a sell sign. The market may be missing the critical element of your Alcoa investing thesis. For historical context, let's compare Alcoa's recent price to its 52-week and five-year highs. I've also included a few other businesses in the same or related industries:

Company

Recent Price

52-Week High

5-Year High

Alcoa $13.38 $17.60 $48.80
Century Aluminum (Nasdaq: CEN) $14.00 $18.77 $80.50
United States Steel (NYSE: X) $46.37 $70.95 $196.00
Kaiser Aluminum (Nasdaq: KALU) $46.12 $47.56 $89.20

Source: Capital IQ, a division of Standard & Poor's.

As you can see, Alcoa is down from its 52-week high. If you bought near the peak, now's the time to think back to why you bought it in the first place. If your reasons still hold true, you shouldn't sell based on this information alone.

Potential sell signs
First, let's look at the gross margins trend, which represents the amount of profit a company makes for each $1 in sales, after deducting all costs directly related to that sale. A deteriorating gross margin over time can indicate that competition has forced the company to lower prices, that it can't control costs, or that its whole industry's facing tough times. Here is Alcoa's gross margin over the past five years:

 

Alcoa is clearly having issues maintaining its gross margin, which tends to dictate a company's overall profitability. Alcoa investors need to keep an eye on this troubling trend over the coming quarters.

Next, let's explore what other investors think about Alcoa. We love the contrarian view here at Fool.com, but we don't mind cheating off of our neighbors every once in a while. For this, we'll examine two metrics: Motley Fool CAPS ratings and short interest. The former tells us how Fool.com's 170,000-strong community of individual analysts rate the stock. The latter shows what proportion of investors are betting that the stock will fall. I'm including other peer companies once again for context.

Company

CAPS Rating (out of 5)

Short Interest (% of Float)

Alcoa 4 6.8
Century Aluminum 3 14.0
United States Steel 4 17.3
Kaiser Aluminum 5 6.3

Source: Capital IQ, a division of Standard & Poor's.

The Fool community is rather bullish on Alcoa. We typically like to see our stocks rated four or five stars. Anything below that is a less-than-bullish indicator. I highly recommend you visit Alcoa's stock pitch page to see the verbatim reasons behind the ratings.

Here, short interest is at a high 6.8%. This typically indicates that large institutional investors are betting against the stock.

Now, let's study Alcoa's debt situation, with a little help from the debt-to-equity ratio. This metric tells us how much debt the company's taken on, relative to its overall capital structure.

 

Alcoa has been taking on some additional debt over the past five years. When we take into account decreasing total equity over the same time period, this has caused debt-to-equity to increase, as seen in the above chart. Based on the trend alone, that's a bad sign. I consider a debt-to-equity ratio below 50% to be healthy, though it varies by industry. Alcoa is currently above this level, at 69.7%.

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If Alcoa had to convert its current assets to cash in one year, how many times over could the company cover its current liabilities? As of the last filing, Alcoa has a current ratio of 1.39. Alcoa could cover its current liabilities, but it's still below a healthy level of 1.5.

Finally, it's highly beneficial to determine whether Alcoa belongs in your portfolio -- and to know how many similar businesses already occupy your stable of investments. If you haven't already, be sure to put your tickers into Fool.com's free portfolio tracker, My Watchlist. You can get started right away by clicking here to add Alcoa.

© 2010 UCLICK L.L.C.