If there was an investing hall of fame, one of the first inductees would no doubt be Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B) CEO Warren Buffett. In his more than five decades at the helm of the company, the so-called “Oracle of Omaha” has amassed a track record that’s unmatched. During his 58-year reign, Berkshire Hathaway stock has risen nearly 20% annually, and in total has surged an eye-popping 3,787,464%.
During uncertain markets and periods of economic instability, investors are looking for any edge they can find to improve their returns. Many turn to Berkshire’s extensive list of holdings as a source of inspiration. One stock that seems particularly compelling right now is Ally Financial (NYSE: ALLY). The ongoing downturn and the recent turmoil in the banking sector have punished the share price, which currently stands 54% below its peak.
Can Ally Financial rebound from the headwinds that have buffeted the stock? Let’s take a step back to look at the bigger picture.
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Banking — no branches required
Unlike many traditional banks, Ally doesn’t have branches on every street corner; instead, it specializes in digital financial services. It offers many of the same services as its brick-and-mortar peers — including checking and savings accounts, certificates of deposit, mortgages, personal loans, and auto loans. Ally also offers a host of investment services, point-of-sale loans, business financing, and even financial services for vehicle dealers.
Because the bank isn’t saddled with legacy real estate and the associated expenses, Ally can offer much higher interest rates than traditional banks with the staffing and upkeep for a multitude of physical locations.
Another factor that works in Ally Financial’s favor is the company’s relentless focus on customer service. This strategy has earned it an 86% customer satisfaction rating from its 11 million customers and a 96% customer retention rate. It also helped the company build a base of $192 billion in total assets. (For full disclosure, I’m also a longtime satisfied customer.)
Strong near-term headwinds…
Ongoing economic headwinds and the recent deteriorating banking climate have sent shivers down the spines of many bank investors, Ally’s included. Yet from a financial perspective, things are pretty much par for the course.
Ally delivered fourth-quarter results that were ahead of expectations, Sure, rapidly rising interest rates have been a thorn in the company’s side; they tend to narrow the spread between the interest the bank pays to depositors and what it earns from loans. Ally’s net interest margin (NIM) of 3.65% fell by 15 basis points. This could deteriorate even further in the coming months, since interest rates are expected to go higher. Management expects its NIM to eventually fall to 3.5% as the federal funds rate peaks.
While this is a challenging situation, it’s one faced by the entire industry, so Ally isn’t alone. The upside is that as the interest-rate environment improves — as it inevitably will — banks will once again be able to widen the spread, which will result in better profitability.
The company faces another challenge. The issues of rising interest rates and high inflation have pinched consumer budgets, weighing on Ally’s auto-lending segment. While things have been — and will likely continue to be — tight, the market has remained stubbornly resilient. U.S. auto sales got a boost in March from fleet sales and truck and SUV sales, as well as the discounts offered by some automakers; this resulted in the market’s best performance in nearly two years.
In anticipation of higher loan defaults, Ally increased its provision for credit losses to $490 million, compared to $280 million in the prior-year quarter, to prepare for tough times ahead. At the same time, delinquencies 30 days or more past due rose to 3.56%, up 66% year over year.
Given the challenging environment, investors would be excused for wanting to stay well clear of Ally Financial — yet Buffett holds a sizable stake in the financial institution. Here’s why.
… Long-term opportunity
In in the midst of a challenging environment, Ally was able to hold its ground, with revenue that was largely flat year over year — despite the obvious headwinds.
Buffett’s affinity for bank stocks is the stuff of legend, and he loves to buy good stocks at great prices; Ally certainly fits both bills. The stock is currently trading for roughly 81% of its book value, a bargain price for a bank. For context, Bank of America — Berkshire’s largest bank holding — trades for 1.27 times book value, which shows just how cheap Ally Financial is by comparison. What’s more, Ally stock is selling for just 5 times earnings, near its all-time low.
This helps put Buffett’s purchases into perspective. Berkshire bought shares in the first quarter of 2022 and tripled that position in the second quarter. The stake currently amounts to 29.8 million shares — or nearly 10% of the total outstanding shares — currently worth more than $776 million.
Let’s not forget that Buffett loves dividends, and Ally checks that box as well. Since kicking off its payout in mid-2016, Ally has grown its dividend by 275%. Its current yield of 4.7% is the result of its pressured stock price. However, the company uses just 29% of its profits to fund the payout, so not only is the dividend likely safe, it will probably go higher from here. Plus, the company has been buying back stock like there’s no tomorrow, reducing its share count by 34% over the past six years.
One final note: Buffett reportedly engaged in discussions with the Biden Administration in the face of the unfolding regional bank crisis. Reports suggested Buffett was providing guidance and might provide an infusion of capital for one or more banks, sparking buzz about a potential Buffett takeover of Ally, though at this point it’s nothing more than a rumor.
Taken together, the long-term opportunities for Ally far outweigh the current challenges. Given the advantages of its digital operating structure, bargain-basement price, and strong and growing dividend, it’s easy to see why Ally Financial hit Buffett’s radar — and why the stock could soar from here.
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Ally 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. Danny Vena has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Bank of America and Berkshire Hathaway. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
