When it comes to successful investing, Berkshire Hathaway (BRK.A 1.75%) (BRK.B 1.85%) CEO Warren Buffett is in a class by himself. The so-called “Oracle of Omaha” has reigned over the company for more than 50 years, building a track record that’s unmatched. Since he took the helm of the conglomerate in 1965, its stock has risen more than 20% annually and has surged a mind-boggling 3,641,613% in total.
When markets are down and uncertainty runs rampant, many investors look to emulate Buffett’s success by finding inspiration among his holdings. One stock that looks particularly interesting right now is Ally Financial (ALLY 3.82%). The bear market has mauled the stock, pushing it down 55% from its high. However, there’s a clear distinction to be drawn between a falling stock price and a company in peril.
Can Ally Financial rebound from the beating that 2022 inflicted on the stock? Let’s take a step back to see what a broader view reveals.
Unlike traditional brick-and-mortar banks, Ally focuses on digital financial services. Sure, it offers all your standard banking services — high-yield checking and savings accounts, certificates of deposit, personal loans, auto loans, and mortgages. The company also boasts an investment services platform, point-of-sale loans, corporate financing, and even vehicle dealer financial services.
However, because of its online access and lack of legacy branches, the company offers more competitive rates than traditional banks saddled with real estate and higher expenses.
Furthermore, Ally Financial’s focus on customer service has served the company well, resulting in an 85% customer satisfaction rating from its 10.8 million customers and $189 billion in total assets (I’m also a satisfied customer).
Short-term, gale-force headwinds…
The deteriorating economic climate has resulted in a perfect storm for some stocks, and Ally Financial hasn’t been immune. With that in mind, let’s talk about the 800-pound gorilla in the room. The company’s third-quarter financial results help illustrate some of the short-term headwinds Ally Financial is facing.
First, the environment of rapidly rising interest rates weighed on results, narrowing the spread between the interest the bank pays to depositors and what it earns on loans. In the third quarter, Ally’s net interest margin (NIM) of 3.81% fell by 0.23%. Furthermore, since interest rates are expected to go higher — again, over the short term — Ally’s take will likely be pinched even further. Management is forecasting its NIM to reach 3.5%.
While this situation isn’t ideal, it’s the reality facing many banks today, so it isn’t unique to Ally. This cloud has a silver lining, however: Over time, banks are able to widen the spread, which ultimately results in improving profitability.
The second headwind Ally is facing is related to its important auto lending business. During periods of economic uncertainty, high inflation, and rising interest rates, people are far less likely to splurge on a new — or even new to them — car.
Furthermore, as the situation worsens, there’s invariably an increase in defaults, as people fail to pay their auto loans. Ally increased its provision for credit losses to $438 million, up $362 million, to prepare for that eventuality. At the same time, delinquencies 30 days or more past due rose to 2.93%, up from 1.83% in the prior-year quarter.
Given the aforementioned challenges, investors might be tempted to steer clear of Ally Financial, so let’s see why Buffett didn’t.
… Equal long-term opportunity
Even in the face of economic headwinds, Ally Financial continued to grow revenue, though at a somewhat tepid pace — up 2% year over year in the third quarter.
As a result of the current climate, there’s a lot of negativity currently baked into the stock price. This is a great situation for investors looking to buy stocks at a discount. Ally Financial’s valuation is ridiculously low right now, when measured using a variety of financial metrics.
It’s well known that Buffett has an affinity for bank stocks, and he loves to buy good stocks at great prices. Ally checks those boxes. The stock is currently trading for less than 75% of its book value — a screaming buy for a bank. For context, Bank of America (BAC 1.00%), Berkshire’s largest bank holding, trades for 1.14 times book value, helping to illustrate just how cheap Ally Financial is. Furthermore, Ally stock is selling for just 4 times earnings, near its all-time low.
This could help explain why Berkshire bought shares in the first quarter, then tripled that position in the second quarter. The stake now amounts to 30 million shares worth more than $757 million.
Finally, Buffett loves dividends, and Ally has a short but growing track record. Since initiating a payout in mid-2016, Ally has increased its dividend by 275%. Its current yield of 4.9% has been driven higher by its declining stock price, but Ally uses just 24% of its profits to fund the payout, so it will likely go higher from here. Furthermore, the company has been buying back stock hand over fist, reducing its share count by 38% over the past six years.
Given the diversity of its business, the opportunity to increase its profitability, and its bargain-basement price, Ally Financial is one Warren Buffett stock that could soar.