This year, shares of Ally Financial (ALLY 1.77%) have been trading hands more often than usual thanks to a tacit endorsement from Warren Buffett. Berkshire Hathaway, the holding company that Buffett's managed since 1965 opened a new position in the all-digital bank during the first quarter and then significantly raised its stake during the second.
On Oct. 20, Ally Financial shares fell slightly because investors are nervous about the company's somewhat negative outlook regarding loan repayment rates. If you're worried that Buffett made a mistake when he bought shares of this bank you might be overreacting. Here's why.
1. Asset quality is normalizing, not deteriorating
Ally Financial, and banks in general, are having a rough time right now thanks to rising interest rates, and a general economic slowdown caused those higher rates. Over time, though, wider spreads between interest paid to savings account holders and the loans Ally originates will improve profitability.
Ally Financial's stock price is under pressure partly because it looks like loan quality is falling apart. For example, retail auto loans that are not expected to be repaid more than quadrupled year over year in the third quarter. This is because the temporary stimulus payments that Americans received in 2021 have dried up.
Rapidly rising charge-offs are troubling, but it doesn't look like investors need to be overly concerned about Ally's asset quality right now. In the third quarter, 30-day delinquencies rose to 2.9% which is still significantly less than pre-pandemic levels.
2. It's a bargain right now
Shares of Ally Financial are trading at just 0.7 times the company's book value. That's a very low valuation for a bank on relatively solid footing.
ALLY Price to Book Value data by YCharts
For example, shares of Wells Fargo and JPMorgan Chase are both trading at prices above their book values. This is a little surprising because the returns on equity (ROE) they've been generating have been significantly smaller than Ally Financial's ROE.
Ally Financial's low valuation essentially means you can buy $1 of Ally Financial's equity for just $0.70. At this knocked-down price, the stock can outperform its peers over time even if it generates similar returns on equity.
3. Originations and deposits are way up
Investors should be encouraged by signs that Ally's gaining a share of the lucrative market for auto loans. Vehicle sales were 11% lower during the third quarter of this year than they were in the third quarter of 2019. Despite this challenging environment, the company expects to originate $48 billion in consumer auto loans this year. That would be 32% more than the company originated in 2019.
Finding new people to lend money to isn't the only area where Ally excels. The number of consumers making deposits at Ally Bank rose for the 54th consecutive quarter to 2.6 million. Since the end of 2019, retail balances have soared 29% to $134 billion.
4. Dividend payouts are rapidly rising
If you're looking for a business that treats its shareholders well it's hard to do better than Ally Financial. Over the past five years, the company has lowered its outstanding share count by nearly one-third.
A much smaller share count makes it easier to commit to higher dividend payments and that's exactly what the company's done. Ally's payout has risen an incredible 150% over the past five years.
With fewer shares outstanding, just 20% of the free cash flow generated by operations over the past year was enough to meet the company's dividend commitment. With such a well-funded dividend program, investors can look forward to some big payout bumps in the years ahead too.
