Why Ally Financial Is a Buy Even If the Markets Sell Off

As global markets grow increasingly nervous over inflation and potential monetary policy changes, investors could benefit from defensive positions in certain financial stocks. Except that recently, some in that sector have behaved more like growth companies, namely the regional banks. At Monday morning's prices, the SPDR Regional Banking ETF is already up 35% this year, compared to the S&P 500's gains of almost 12%.

Ally Financial (ALLY 1.77%) is one of the top performers, rising 50% itself. The digital bank has the largest auto loan portfolio in America, and is rapidly expanding into other areas of lending. It has grown revenue and earnings materially, and thanks to some favorable economic conditions, there's a good chance it's not done. 

Image source: Getty Images.

Strong tailwinds

Ally Financial holds $103 billion in car loans as of the first quarter, making the company susceptible to significant changes in the auto industry. This year, dealers have faced unprecedented new car shortages as a result of the enormous demand for semiconductors, combined with pandemic-related supply chain backlogs. Some dealers have seen an 80% fall in their available inventories, which means consumers are facing lengthy waits to take delivery of their new vehicles.

The shortages pushed prices to all-time record levels, with the average for new cars hitting almost $40,000 in April. Used cars followed as consumers turned to private sellers, with prices crossing $23,000 for the first time ever. 

U.S. consumers are saving money at record levels, thanks to the stay-at-home economy stifling opportunities for them to spend. Plus, they've received trillions of dollars in stimulus that appears to be remaining in bank accounts rather than flowing into the economy. According to the St. Louis Federal Reserve, the savings rate was at 27.4% in March, compared to 8% in March 2019, when things were more normal. 

It's possible a perfect situation is brewing for Ally Financial's business. The economy is set for strong growth over the next year, as consumers return to normal life and exercise some of their pent-up demand for products. With record levels of savings, and wait times for cars that will gradually ease going forward, plus record high car prices -- Ally could see meaningful growth in its loan book. 

Still a great value

Despite the stock delivering a 358% return from the pandemic low point set in March 2020, it remains cheap by some financial metrics, and against the SPDR Regional Banking ETF. 

Data source: Company filings. Prices at the morning of Monday, May 24, 2021.

Ally Financial earned $3.34 per share for the full year in 2018, and $3.72 in 2019 (these aren't according to generally accepted accounting principles -- they're adjusted to exclude discontinued operations and non-recurring items, making the numbers a little less "noisy"). Its stock traded at earnings multiples of 7.8 times and 8.6 times, respectively. So right now, there is an argument that the 9.6 multiple is high. But there's a key difference -- earnings per share is growing rapidly at the moment. 

In fact, analysts expect Ally to earn $6.34 for the full year 2021 (average forecast), according to Yahoo! Finance. This would be 70% growth compared to the 2019 result, and would explain why the current trailing multiple is slightly higher than the last few years (investors tend to pay a premium when companies are growing). 

However, ascribing this estimate to the current share price gives an 8.4 multiple. It's worth noting that the company has already delivered $2.09 in Q1 2021 earnings, so keeping up this pace, it could even surpass the estimate. 

The SPDR Regional Banking ETF trades at 13.5 times forecasted 2021 earnings, so Ally Financial is still trading well below this key index. 

Looking forward

Since the start of 2021, about $32 billion has flowed into financial stocks, which is now the highest ever for a full year, let alone just a six-month stretch. Investors are favoring companies that typically fall into the value category, and have been selling high-flying tech names that generate little to no earnings. Ally might be a great investment right now because it offers the consistent revenue stream and predictability of a bank, with the added benefit of rapidly growing earnings.

The economic tailwinds that have carried the company this far look set to continue, but Ally might also catch some additional revenue from modestly higher interest rates over the next year. During this time, we should experience some relief from recent semiconductor shortages, meaning more cars being delivered to consumers -- bolstering Ally's loan book. 

For investors looking to rotate out of some presently turbulent high-growth stocks, Ally presents an opportunity to earn a return from strong earnings and some possible multiple expansion, which could continue flowing through the rest of 2021 and into 2022.