U.S. markets closed
  • S&P Futures

    4,011.75
    +8.50 (+0.21%)
     
  • Dow Futures

    34,063.00
    +77.00 (+0.23%)
     
  • Nasdaq Futures

    11,826.00
    +20.25 (+0.17%)
     
  • Russell 2000 Futures

    1,846.00
    +4.10 (+0.22%)
     
  • Crude Oil

    77.60
    +0.67 (+0.87%)
     
  • Gold

    1,786.00
    +4.70 (+0.26%)
     
  • Silver

    22.31
    +0.11 (+0.50%)
     
  • EUR/USD

    1.0509
    +0.0011 (+0.11%)
     
  • 10-Yr Bond

    3.5990
    +0.0930 (+2.65%)
     
  • Vix

    20.75
    +1.69 (+8.87%)
     
  • GBP/USD

    1.2211
    +0.0017 (+0.14%)
     
  • USD/JPY

    136.8440
    +0.1590 (+0.12%)
     
  • BTC-USD

    17,046.12
    -206.86 (-1.20%)
     
  • CMC Crypto 200

    403.06
    -8.15 (-1.98%)
     
  • FTSE 100

    7,567.54
    +11.31 (+0.15%)
     
  • Nikkei 225

    27,902.11
    +81.71 (+0.29%)
     

Declining Stock and Decent Financials: Is The Market Wrong About Alcoa Corporation (NYSE:AA)?

Alcoa (NYSE:AA) has had a rough month with its share price down 22%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Alcoa's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Alcoa

How Do You Calculate Return On Equity?

Return on equity can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Alcoa is:

17% = US$1.2b ÷ US$7.3b (Based on the trailing twelve months to June 2022).

The 'return' is the amount earned after tax over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.17 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Alcoa's Earnings Growth And 17% ROE

At first glance, Alcoa seems to have a decent ROE. Even so, when compared with the average industry ROE of 21%, we aren't very excited. Alcoa was still able to see a decent net income growth of 19% over the past five years. Therefore, the growth in earnings could probably have been caused by other variables. Such as - high earnings retention or an efficient management in place. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this also does lend some color to the fairly high earnings growth seen by the company.

We then compared Alcoa's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 28% in the same period, which is a bit concerning.

past-earnings-growth
past-earnings-growth

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Alcoa's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Alcoa Using Its Retained Earnings Effectively?

Alcoa has a low three-year median payout ratio of 5.1%, meaning that the company retains the remaining 95% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

While Alcoa has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 5.4%. As a result, Alcoa's ROE is not expected to change by much either, which we inferred from the analyst estimate of 17% for future ROE.

Summary

On the whole, we do feel that Alcoa has some positive attributes. Specifically, we like that the company is reinvesting a huge chunk of its profits at a respectable rate of return. This of course has caused the company to see a good amount of growth in its earnings. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Join A Paid User Research Session
You’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here