A value stock is generally described as a stock that is worth more or has a higher intrinsic value than the stock price indicates. Value investors identify these stocks in several ways -- including a low price-to-earnings (P/E) ratio, a low P/E-to-growth (PEG) ratio, or a low price-to-book (P/B) ratio. The idea, of course, is to buy these undervalued stocks in the hopes that they increase in price and realize their true value.
One stock, in particular, that is undervalued relative to its growth potential is Ally Financial (ALLY -1.39%). Here's why this is a top value stock right now.
Ally makes a major acquisition
Ally Financial is a digital-only bank that is one of the nationʻs top two auto lenders, along with Capital One Financial. Itʻs no wonder, since Allyʻs roots are in the auto industry -- it began as GMAC Financing, providing loans to General Motors customers.
Ally is coming off an excellent third quarter, as revenue increased 18% year over year to $2 billion and net income climbed 43% year over year to $683 million. About two-thirds of Ally's revenue, or roughly $1.3 billion, came from auto financing, which saw a 20.6% increase year over year. Auto loan originations were $12.3 billion in Q3, up from $9.8 billion a year ago. It was the company's highest third quarter since 2006 for auto loan originations.
The stock price is up about 36% year to date and is trading at around $48.50 per share. But since the Q3 earnings came out, shares have fallen about 13%, which doesn't fully compute given the strong performance and earnings beat. Maybe investors were spooked by higher expenses due to technology upgrades and marketing costs to fund Ally's new campaign -- "We're All Better Off with an Ally," the largest in its history.
It could also be due to macroeconomic concerns, like inflation and COVID-19, or the chip shortage/supply chain issues, which hurt the auto industry, particularly in Q3.
Another factor may be its purchase of Fair Square Financial, a digital credit card company, for $750 million. The deal was made to further diversify its revenue stream and bolster its credit card business, bringing some 658,000 cardholders and $763 million in loan balances to Ally. "Adding a credit card capability has been an important objective for us, and today, we're announcing the opportunity to address this key product gap," CEO Jeffrey Brown explained on the Q3 earnings call.
Just before the pandemic hit, Ally had announced a deal to buy CardWorks, a credit card company, but the deal fell through once the pandemic hit. Maybe some investors question this move into a crowded space, which has gotten even more competitive with payment apps and buy now, pay later providers popping up all over the place.
Ally expects Fair Square to be accretive to earnings starting next year. "Once closed, we expect the transaction to be accretive to earnings by late 2022 and to full-year 2023, while adding 100 basis points to 150 basis points to our returns as we organically grow the portfolio," CFO Jen LaClair said on the Q3 call.
A good value
Whatever the reason for the sell-off, it's good news for investors because this stock has become an even better value. It has a price-to-earnings ratio of 5.9 with a forward P/E ratio projected over the next 12 months, which is about the same. In addition, it has a five-year PEG ratio of just 0.30. These metrics indicate a stock that is undervalued in relation to its near- and longer-term growth expectations.
Despite the market reaction, the Fair Square deal is a good one because it helps diversify Ally's revenue stream and adds a key component toward Ally's goal of scaling up as a full-scale digital bank. It's also a good fit as it's a digital credit card company coming to the leading online bank, and it provides Ally with an opportunity to bring in new customers and deepen existing relationships.
Also, as a leading auto lender, Ally should benefit over the next few years as the auto sales market bounces back in 2022 from pent-up demand and begins to normalize in 2023.
All in all, if you are looking for a solid value stock in your portfolio, Ally is a pretty good option.