In its recently released 13F regulatory filing, which shows what stocks a company bought and sold in any given quarter, Warren Buffett's conglomerate Berkshire Hathaway (BRK.A -0.49%) (BRK.B -0.55%) disclosed a new stake in the digital consumer bank Ally Financial (ALLY 1.63%). Berkshire purchased roughly 8.97 million shares in the first quarter of 2022 for a total value of close to $390 million. Berkshire's average cost was roughly $43.48 per share.

Ally is by no means a big position for Berkshire and makes up just a small fraction of the holding company's nearly $347 billion equities portfolio. But the move is interesting, nonetheless, considering Berkshire sold so many of its other bank holdings in 2020 and 2021. Should you invest alongside Buffett and Berkshire in Ally? Let's take a look.

Warren Buffett.

Image source: Motley Fool.

Meet Ally Financial

Ally is the largest direct-to-consumer digital bank in the U.S., with more than $184 billion of assets under management at the end of the first quarter of this year, making it the 23rd largest bank in the U.S. by assets, according to the FDIC.

Ally has no physical branches and focuses on serving many financial needs of the consumer. It's mainly in the auto lending business but also has a big mortgage portfolio, and originates personal, credit card, and point-of-sale loans. Ally also has an insurance business, an online brokerage and wealth management division with close to $17 billion in client assets, and does commercial lending in the auto industry as well as corporate finance.

Ally has benefited immensely from the auto boom that started as a result of the pandemic and that has pushed vehicle prices up, particularly in the used-car space. In the first quarter of 2022, Ally originated $11.6 billion of retail auto loans from 3.2 million applications, the highest level of originations the company has seen in the first quarter in 11 years. The average yield on the portfolio came in strong as well, exceeding 7%. The increased activity in the auto space has also carried over to other parts of Ally's business.

Ally Financial loan and product growth.

Image source: Ally Financial.

This increased activity helped Ally deliver a more than 24% return on tangible common equity (ROTCE) in 2021, which is essentially more than double any other ROTCE that Ally has generated since going public in 2014. 

A classic Buffett play

Similar to Berkshire's purchase of Citigroup stock in Q1, Ally looks like a classic Buffett value play. The stock is cheap at just about 110% of its tangible book value, which is essentially a bank's net worth. Ally stock also trades at about 5.2 times forward earnings. Both of these valuations are very cheap for a company that just produced a 24% ROTCE.

But of course, there is a reason for the discount. As high levels of inflation persist and the Federal Reserve aggressively raises interest rates, which increases the cost of debt, the market is worried about the financial health of the consumer, especially if the economy tips into a recession.

That could result in more loan losses in Ally's auto portfolio and other consumer lending portfolios. For the last five quarters, the auto origination portfolio has had a weighted average FICO score above 680, which are prime borrowers. The bank has built a reserve coverage ratio for its auto portfolio of 3.49%, meaning it is reserving enough capital right now to cover losses on 3.49% of its auto loan book. Delinquencies and loan losses are both below 0.60% of the total auto loan portfolio but are expected to normalize and rise.

The other thing that makes Ally a classic Buffett play is the fact that it has a solid dividend yield of close to 2.7% and it repurchases a lot of stock. Since 2016, Ally has repurchased more than 32% of its outstanding shares and is also planning to buy back $2 billion of stock this year.

Should you invest?

I agree with Buffett and Berkshire that Ally presents a very solid risk-reward opportunity. The business is in much better shape than it was prior to the pandemic, not only because of the auto boom, but also because Ally has a much better core deposit base and overall customer base than it used to. Management at Ally knows conditions will normalize in terms of credit and auto loan originations, and it is also preparing for used-vehicle prices to come down.

Despite the normalization, Ally is still guiding for a medium-term ROTCE between 16% and 18%, which is a much better return than Ally ever generated prior to the pandemic. The company also continues to reward shareholders with a solid dividend and lots of share repurchases.

There is the risk of being exposed to the consumer, which could find themselves in a recession at some point, but similar to Buffett and Berkshire, I think Ally stock is worth at least dedicating a small portion of your portfolio.