The stock market has been making some shifts in response to the macroeconomic environment. After two years of pandemic-related stimulus, the Federal Reserve has said it will taper its quantitative easing program and implement a series of interest rate hikes in 2022.
This will create headwinds in some sectors of the market -- like technology, where companies are often fast-growing (but unprofitable) and therefore more difficult to value. That's because higher interest rates provide investors with safer alternatives to stocks, which affects the price they're willing to pay for them.
But some companies could benefit from this new environment. One, Ally Financial (ALLY 0.75%), is America's No. 1 digital bank, and its stock currently trades at an extremely attractive valuation.
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The leader in auto loans
Ally isn't a typical bank. With no physical branches, it relies on its mobile app and web-based storefront to serve its customers. It's therefore impressive that Ally has become the No. 1 car lender in the U.S., with $105.2 billion in total loans as of the end of 2021.
Ally's relationships with 21,100 automotive dealerships across the country provide it with perhaps its greatest competitive advantage. These dealers originated 13 million customer applications for Ally during 2021 (a record high), which led to $46.3 billion in car loans. Additionally, a smaller cohort of 4,500 dealers sourced $1.2 billion worth of premiums for Ally's car insurance business.
Despite the low-interest-rate environment, Ally's yield on its car loan portfolio ticked up slightly from 6.77% in 2020 to 6.87% in 2021. It's even higher than the pre-pandemic level of 6.61% in 2019. That resulted in a stellar net income of $3.3 billion for its automotive finance segment, representing 163% year-over-year growth. Car loans are riskier than home loans, so lenders have more flexibility to charge higher rates, even with the fed funds rate near zero.
Entering new markets
Ally isn't a one-trick pony. With 10.5 million customers, it has also expanded into other segments (for example, it now operates a stock brokerage), and is attempting to grow its mortgage business with great success.
|
Metric |
2018 |
2021 |
CAGR |
|---|---|---|---|
|
Mortgage originations |
$700 million |
$10.4 billion |
145% |
Data source: Ally Financial. CAGR = Compound annual growth rate.
Since housing finance is the largest lending market in the U.S., with an estimated $4.5 trillion in originations each year, Ally's expansion into it should be welcomed by investors. And it has only scratched the surface of this opportunity, especially as it offers customers a more modern experience than many of its competitors through its all-digital approach.
Ally claims its technology has automated 70% of its car loan approvals. If it can eventually apply this model to mortgages, it could win significant market share, as the loan-decision process is typically slow and clunky throughout the industry.
The company has also experienced strong growth in its Ally Invest platform, which is targeted toward customers wanting to buy and sell stocks and other financial assets. At the end of 2021, its customers held $17.4 billion worth of these investments with Ally, up 24% from the end of 2020.
Why the stock is a buy now
Ally has a history of rewarding its shareholders, and in 2022, it's set to return a record amount of money to them. In 2021, it paid $0.88 per share in dividends. This year, it's expected to distribute at least $1.20 per share. At Monday's closing stock price of $47.72, that gives it a yield of 2.5%.
Additionally, Ally repurchased $2 billion worth of its stock in 2021 and plans another $2 billion worth of repurchases this year. Buybacks reduce the amount of stock in circulation, organically boosting the share price.
Based on 2021's earnings per share of $8.61, Ally's stock trades at a price-to-earnings multiple of just 5.5. That's far cheaper than the broad S&P 500 index, which trades at a multiple of 25.9, even though Ally grew its earnings in 2021 by 184%.
The reason for that discount is the outlook for Ally. Analysts anticipate that its earnings will contract to $7.58 per share in 2022, then grow to $7.99 in 2023. Typically, when a company isn't growing its earnings, investors reduce the premium they're willing to pay for its stock. But it's important to remember that segments like its mortgage business, which is growing by triple-digit percentages each year, could become major drivers of the overall business.
And if Ally delivers $7.58 in earnings for 2022, that would still be more than twice as much as the company's next-best result between 2015 and 2020. Combine that with its robust dividend and share-repurchase program, and Ally looks like a great stock to hold in a year of heightened market volatility.
