I have made no secret of the fact that I do not admire the aluminum business model in general and at Alcoa, specifically. It is not an insight that I can take credit for. A few years back, I stumbled upon the Credit Suisse century in review white paper that discussed the best and worst investments that could have been made between 1901 and 2012. It taught me that vice is much more lucrative than even the people who know those industries make a killing give it credit for–receiving tobacco and beer dividends for decades on end has been one of the surest ways to increase your standard of living through passive investments.
But it has also taught me to avoid the shipbuilding and aluminum industries altogether. Silence of the Lambs has gotten nothing on the horror these two sectors have inflicted on their shareholders over the years. With aluminum stocks, you have only generated a compounded rate of 5.4% over 100+ years, and the figure drops to 3.8% when you measure the period from 1980 onward. If you created your own cap-weighted aluminum index thirty-six years ago, you would have only compounded at a rate that barely eclipsed inflation. American investors in these two sectors would have spent over half their lives waiting for a moment that would never come.
The business model is awful. Alcoa earns somewhere between $0.40 per share and $0.50 per share, about one-fourth of what it did during the 1990s. It carries over $9 billion in debt that is roughly twenty times the profit. It has a twenty-year record of delivering NEGATIVE earnings growth of over 5%.
That’s why I’m really curious as to who those people are that get bothered by Alcoa’s earnings disappointment today that sent the price down 6% as it was revealed that Alcoa is generating 7% less revenues this year compared to last year (while almost all cyclicals, including the oil companies, are reporting better 2016 earnings than 2015 earnings.) Who are the people that get perpetually rocked by this?
I’m convinced that it must be index investors in things like the S&P 500 which are weighed mostly by market-cap and include firms like Alcoa automatically simply because of its size.
Formulaic buying is the only explanation I can come up with.
Incidentally, this stock is my personal shorthand for why I find S&P 500 Index investing unappealing. Over a 25+ year time frame, I would guess there is a nearly 90% chance that Alcoa will earn six tenths of the total returns generated by the S&P 500 Index or less. If I had to come up with the surest way to beat the S&P 500 Index Fund over the long term, I would just buy all the companies already in the index and exclude Alcoa.
But, of course, once you do that, the list itself narrows further. You’d also exclude airlines. And shipbuilders. And, for most of the past few years, you’d want to exclude a good chunk of the REITs and utilities based on valuation. And before you know it, you will find yourself left with businesses that generally have great historical records, great present records, and a high possibility that the status quo that existed in the past will also exist in the future.
The crazy thing is that, as bad as Alcoa has been the past few years, things could actually get worse considering that Chinese aluminum suppliers are ramping up export production to the United States and aluminum prices are already pretty low as it is. The same bad news that has been destroyed 75% of Alcoa’s shareholder value over the past eight years is likely slated to continue.
At some point in the future, Alcoa will have a good earnings or two, and perhaps pop up 15%. You might wonder: Am I wrong? Nope. Wait a couple of years, and before you know, Alcoa will fall to its prior low. There are probably even odds that this company will go bankrupt within the next 25 years. It is almost certain that it will underperform the S&P 500 over any rolling 25+ year time frame. The best case scenario is that you beat inflation by a point or two over the long haul, and the worst case scenario is that you lose everything. It is a minimal upside, lots of downside type of investment. If you personally find yourself beating the performance of the S&P 500 over the years, the fact that index funds get saddled with Alcoa will be one of the contributing reasons why.