Warren Buffett's company Berkshire Hathaway (BRK.A -0.55%) (BRK.B -0.47%) owns at least half a dozen bank stocks, and many of these holdings are highly regarded in the industry. But there are some banks that Berkshire has invested in this year that have not only seen their stock prices dip sharply but are also trading at extremely low valuations.
Buffett has always advised traders to be greedy when others are fearful, and Berkshire is certainly following that advice by investing in these two beaten-down stocks. Here's why.
1. Citigroup
For more than two decades, Buffett and Berkshire passed over Citigroup (C 1.18%), instead deciding to invest in nearly all of Citigroup's peers. But in the first quarter of this year, Berkshire took a new stake in Citigroup, purchasing more than 55.1 million shares valued at about $2.5 billion. Citigroup's stock has fallen close to 20% this year and now trades at roughly 63% of its tangible book value, or net worth.
Buffett seems to finally like Citigroup's transformation plan after years of generating sub-par returns that have lagged behind its large-bank peers. Under the new leadership of CEO Jane Fraser, the bank made the decision to exit its international consumer banking operations in 14 global markets, including its very profitable Mexico division, Citibanamex. That will free up capital that Citigroup can use to meet higher regulatory capital requirements, invest in the bank's operations, and eventually repurchase stock.
Citigroup plans to invest more in areas the bank already does well in, like investment banking, treasury and trade solutions, securities services, and international wealth management. The bank also has work to do on the regulatory front, including fixing internal controls and modernizing the bank's operations.
While Citigroup has struggled for many years now and the transformation could take several years, I think Buffett likes the fact that Citigroup will become simpler and more capital efficient with these moves. Citigroup is really everything that Buffett has traditionally invested in: It is a value play, there is a turnaround plan in place, the bank pays a healthy 4% dividend, and it will repurchase stock when it can.
2. Ally Financial
Berkshire in the first and second quarter of this year also purchased shares of the large consumer digital bank Ally Financial (ALLY 0.89%), which specialized in the auto space. Following the second quarter, Berkshire owned 30 million shares of Ally valued at more than $1 billion. Ally's stock is down more than 30% this year, and the stock trades at just 97% of its tangible book value.
There's been a lot to like about Ally in recent years, as the company has benefitted from the chip shortage that has driven car prices higher. Retail auto loan balances in the second quarter of 2022 were up roughly $9.5 billion from the second quarter of 2019, and these loans are being originated with high yields. This is part of the reason Ally managed to generate a core return on tangible common equity (ROTCE) of more than 23%, which is very strong. Ally has also done a nice job of improving its funding base in recent years.
But car prices have been particularly elevated in recent years, especially among used cars, and many expect auto prices to eventually come back down. Ally also started to see retail delinquencies tick up in the second quarter and will also likely face much higher funding costs as the Federal Reserve continues to jack up rates. Still, Ally is modeling for used car prices to come down by 30% by 2023, and Buffett is no stranger to the car business, with Berkshire having invested in General Motors for a number of years now.
Ally is another stock that makes a lot of sense for Buffett. It's trading at a very low valuation given the returns it can put up, it pays a healthy 3.4% dividend yield, and the company is also known to repurchase a lot of stock.
