There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. With that in mind, we've noticed some promising trends at Alcoa (NYSE:AA) so let's look a bit deeper.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Alcoa, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.09 = US$1.1b ÷ (US$14b - US$2.7b) (Based on the trailing twelve months to June 2021).
Therefore, Alcoa has an ROCE of 9.0%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 11%.
In the above chart we have measured Alcoa's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Alcoa here for free.
How Are Returns Trending?
Alcoa has not disappointed with their ROCE growth. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 247% over the last five years. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.
The Key Takeaway
As discussed above, Alcoa appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Since the total return from the stock has been almost flat over the last three years, there might be an opportunity here if the valuation looks good. With that in mind, we believe the promising trends warrant this stock for further investigation.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Alcoa (of which 1 can't be ignored!) that you should know about.
While Alcoa may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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What are the risks and opportunities for Alcoa?
Trading at 51.4% below our estimate of its fair value
Earnings are forecast to grow 73.83% per year
No risks detected for AA from our risks checks.
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Alcoa Corporation, together with its subsidiaries, produces and sells bauxite, alumina, and aluminum products in the United States, Spain, Australia, Iceland, Norway, Brazil, Canada, and internationally.
Excellent balance sheet and good value.