What happened
Shares of large digital consumer bank Ally Financial (ALLY 0.13%) rose more than 10% in May, according to data provided by S&P Global Market Intelligence. The main reason for the move looks to be the revelation that legendary investor Warren Buffett and his company Berkshire Hathaway have taken a small stake in the company.
So what
In Berkshire's 13F filing for the first quarter of the year, which shows what stocks the company bought during that three-month time frame, Berkshire disclosed that it had purchased roughly 8.97 million shares of Ally valued at close to $390 million. That means Buffett and Berkshire purchased shares at an average cost of roughly $43.82.
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It's not a huge position for Buffett and only makes up about 0.1% of Berkshire's roughly $347.6 billion equities portfolio. But any time Buffett and Berkshire take a position it's certainly a big deal.
While it's hard to tell if Buffett made the Ally pick himself, there are a lot of reasons why the Oracle of Omaha might like the stock. For one, the stock looks like a value play, trading at cheap multiples, whether it's on a forward earnings basis or based on Ally's tangible book value, which is basically its net worth.
ALLY Price to Tangible Book Value data by YCharts
Additionally, Buffett would probably like a company like Ally because it returns a lot of stock to shareholders. Ally has a solid annual dividend yield of roughly 2.6%. It's even better when it comes to buying back stock. Since 2016, Ally has bought back 157 million shares and is planning to repurchase $2 billion worth of stock this year, which equates to about 14% of its total market cap.
Ally had a tremendous year in 2021, generating a more than 24% return on tangible common equity (ROTCE), thanks to strong credit quality and a robust auto lending market. The returns were elevated due to reserve releases of capital previously stored away for loan losses that never materialized. But Ally is still targeting a 16% to 18% ROTCE in the medium term.
Now what
As a consumer bank heavily concentrated in auto lending, Ally certainly faces risks if there is a recession. Loan losses could pile up and elevated car values could come crashing down. But Ally management appears prepared for prices to come down and the bank has greatly improved its deposit base in recent years.
Considering the valuation, strong expected returns, and high level of capital returns, Buffett and Berkshire look like they are onto something with this recent investment.
