It’s no secret that Warren Buffett loves stocks from the financial sector, as you’ll find several big banks among Berkshire Hathaway. And in 2022, a new banking stock was added to the portfolio: Allied Financial (ALLY 0.97%).
Berkshire bought about 3% of Ally’s outstanding shares in the first quarter, but more than tripled its position in the second. The conglomerate now owns about 9.3% of Ally, a stake of just over $1 billion. And after some research, Ally jumped to the top of my own watch list. Here’s why.
Ally Financial’s business – the short version
Ally Financial has been around for a long time, but before the financial crisis it was a subsidiary of General Engines known as GMAC Financial.
With that in mind, you might guess that one of Ally’s main focuses is auto lending, and you’d be right. But in recent years, the company has evolved into so much more. It has a large insurance brokerage that has a natural source of customers through its auto loan platform. And Ally also operates a successful online bank that offers high-yield deposit accounts, mortgages, personal loans, credit cards and an investment platform. In total, Ally Bank has approximately 2.5 million retail customers, which has more than doubled over the past five years. Ally is the largest all-digital direct U.S. bank and has grown its customer base for 53 consecutive quarters.
Why is Ally such an attractive investment?
On the one hand, Ally is an extremely profitable business. Consider its auto-lending operation. In the second quarter of 2022, Ally issued $13.3 billion in auto loans at an average yield of 7.8%. Meanwhile, Ally Bank has about $140 billion in deposits (which it uses to fund its lending operations) that pay an average interest rate of just 0.76%. Its annual net imputation rate (NCO) is less than 0.5%. It doesn’t take heavy math to see why this can be a lucrative business.
Ally has generated an average return on equity of 16.9% over the past four quarters, well above that of a typical bank, fueled both by the high yield nature of its lending products and the benefits costs that come with being an online bank.
Not only is Ally profitable, but its action is cheap. It trades at less than 0.95 times book value and just over five times earnings. For context, mega-bank JPMorgan Chase trades for 1.41 times the pound and about 10 times earnings, despite significantly lower ROE and interest margins. Same Bank of Americawhich is Berkshire’s largest bank stock investment and is often considered a “cheap” bank stock, trades at 1.2 times the pound.
Last but not least, Ally does a great job of returning capital to shareholders, which likely has a lot to do with Buffett’s investment thesis. It has a dividend yield of 3.3%, but the company’s main capital return focus is redemptions – which is no surprise given that it literally trades for less than the value of its shares. assets. In the first half of 2022 alone, Ally spent $1.2 billion on stock buybacks, an extremely aggressive rate for a company with a market capitalization of around $11 billion. Since 2016, Ally’s outstanding shares have fallen more than 36%, and buyouts like this can become a major driver of shareholder return over time.
Is Ally Financial a buy right now?
To be perfectly clear, it’s not a good idea to get into investing just because a billionaire investor is doing it, even if that billionaire investor is called Warren Buffett. That said, it’s not hard to see why Buffett (or someone from Berkshire’s investment team) might be a big fan of the bank.
There are certain risk factors to be aware of. For one thing, the auto industry is certainly facing near-term headwinds, such as supply chain disruptions. And if the economy falls into a recession, we could see an increase in defaults and a drop in demand for new loans. However, given the bank’s success and profitability, the stock’s risk-reward profile looks very favorable to patient long-term investors.
Ally is an advertising partner of The Ascent, a Motley Fool company. JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Bank of America is an advertising partner of The Ascent, a Motley Fool company. Matthew Frankel, CFP® has positions in Bank of America, Berkshire Hathaway (B shares) and General Motors. The Motley Fool holds positions and recommends Berkshire Hathaway (B shares). The Motley Fool recommends the following options: $200 long calls in January 2023 on Berkshire Hathaway (B shares), $200 short puts in January 2023 on Berkshire Hathaway (B shares) and short calls of $265 in January 2023 on Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.