In the first quarter of the year, Warren Buffett and his company Berkshire Hathaway (BRK.A -0.64%) (BRK.B -0.73%) opened up a position in the large consumer digital bank Ally Financial (ALLY -0.84%). It wasn't a huge investment for Berkshire, but the move is interesting because Ally isn't just a bank, but it's also a digital bank with no branches. It's also interesting that Ally's business, although heavily focused on the auto space, looks quite similar to the popular fintech, SoFi Technologies (SOFI -1.60%), which is also a digital consumer bank.
So what makes Ally a Buffett stock over SoFi? Let's take a look.
SoFi vs. Ally
Many investors are now familiar with SoFi's business and it's been quite popular since going public at the end of 2020, although the stock, like many other fintech companies, has not fared well. SoFi's goal is to become a one-stop-shop for high-income earners and provide them with all of their financial needs. The company offers bank accounts, online investing, and various lending products such as mortgages, credit cards, and personal and student loans. SoFi has more than $12 billion of assets and about 3.9 million members. SoFi also has a bank technology business with its acquisitions of Galileo and Technisys.
Ally offers a similar proposition, but while SoFi specializes in student lending, Ally specializes in auto lending. Still, the company also wants to serve the customer in many other ways and offers bank accounts, mortgages, credit cards, point-of-sale lending, insurance, and online investing. Ally also has a commercial lending business, in which it serves auto dealerships. Ally has been around longer and is definitely more developed than SoFi, with 10.5 million customers and more than $184 billion of total assets.
Valuation and capital returns
I am sure there are many, many factors that Buffett and Berkshire take into consideration before investing in a stock, but two things that make Ally look more like a Buffett investment than SoFi are its valuation and large capital return programs. Buffett has long been a value investor who tries to find stocks trading below their intrinsic value.
Ally stock trades at just above tangible book value, or its net worth, and below five times forward earnings, both of which are cheap. SoFi trades above 240% of its tangible book value and 71 times its 2022 projected adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA), which are both expensive growth valuations. Ally is also coming off an extremely profitable year in which it generated more than a 24% return on tangible common equity, which was certainly elevated, but the company is projecting much better returns going forward than it generated pre-pandemic.
Additionally, we know Buffett loves companies that return capital to shareholders through share repurchases and dividends. Ally checks both of these boxes while SoFi, which again is much earlier in its journey, doesn't yet offer a dividend or repurchase stock. At current trading levels, Ally has a solid annual dividend yield of 2.85%. The company has also bought back a ton of stock since going public and is planning to execute a $2 billion buyback plan this year.
The lessons of Ally
I actually can't say with certainty that Buffett was the one who pulled the trigger on Ally -- it could have been one of his investing lieutenants. Ally also has a lot of exposure to the consumer, so a recession would likely be bad for its business. But Buffett knows banks very well and also knows the car business quite well, having owned General Motors stock for a number of years. Ally was spun off from General Motors.
But what makes Ally a Buffett stock is definitely its cheap valuation and strong capital return program. SoFi is still in the early stage of its business, has a much higher valuation, and is not doing capital returns yet. Berkshire has been known to invest in unprofitable fintech companies before, but that's typically in countries outside the U.S., where they can be much bigger disruptors and have much bigger market opportunities. I think SoFi still has a ways to go before becoming a traditional Buffett stock.