With the tech-heavy Nasdaq Composite up about 30% year to date, it's increasingly difficult to find great companies with shares trading at good prices. But they're still out there. Investors, however, may have to walk away from the crowd to find them. For instance, there are a handful of opportunities within the financial sector, which has underperformed dramatically this year as investors fret over how rising interest rates will impact loan affordability, lending, and net-interest margin.
One opportunity in the sector looking like a steal today is Ally Financial (ALLY 0.41%). The direct-to-consumer bank has spooked investors since much of its business is tied to car loans, and it's no secret that used car sales have been suffering, and many vehicle manufacturers have been slashing the prices on their new cars to help offset weakening demand. But with the stock now trading well below book value and at just 7 times earnings, these challenges may be already priced into the stock.
A dirt-cheap valuation
As many investors have chased tech stocks like Nvidia, Meta Platforms, and Microsoft in 2023, Ally has lagged far behind the Nasdaq and most megacap tech stocks, rising just 7% year to date. Furthermore, the stock has fallen 25% over the last 12 months while the Nasdaq rose 9%. This underperformance, however, may be an opportunity for investors willing to be fearful when others are greedy.
To be clear, things have been rough for Ally. Second-quarter adjusted net income fell 34% year over year to $301 million as total loan originations declined sharply. Moreover, the company's net-interest margin continued to come under pressure, coming in at 3.38% for the period -- down from 4.04% in the year-ago quarter.
But we may be close to a trough in Ally's earnings pullback. Indeed, analysts, on average, expect adjusted earnings per share to rise from $3.66 for the trailing-12-month period to $4.41 in 2024. Notably, however, it may get worse before it gets better; the consensus forecast calls for several quarters of year-over-year declines in adjusted earnings before the company returns to growth.
Supporting the thesis for the company's earnings slide to subside at some point next year, Ally management said in its quarterly update earlier this month that it expects its net-interest margin will trough during Q1 2024, assuming the fed funds rate peaks at 5.50%. In addition, Ally anticipates net-interest margin expansion next year due to its earning asset yield momentum and based on its modeled scenario for the fed funds rate.
Of course, this analysis shows how dependent Ally is on the Federal Reserve's decisions. But such is banking.
Fortunately, the market seems to have already priced in some significant risks to owning the stock. Indeed, investors get to rake in an excellent dividend yield while they wait to see how things work out with the Federal Reserve. Ally stock pays a meaty dividend yield of 4.6% at its current price.
1 major potential catalyst
A potential catalyst for the stock is the possible resumption of Ally's share-repurchase program. Before the program paused this year, the company was aggressively buying back its stock. Indeed, it repurchased $1.7 billion of its shares in 2022. If the interest rate environment stabilizes and Ally's loan originations hit a trough soon, the company could opt to resume its share-repurchase program. With the stock's current market capitalization sitting below $8 billion, even repurchases of $100 million per quarter could make a meaningful difference and create substantial shareholder value. A program like this would eliminate more than 5% of Ally's shares outstanding over the course of just 12 months, assuming management could buy back stock at an average price of about $26.
Overall, there are a lot of risks to owning Ally stock, particularly as high interest rates increase the odds of the U.S. falling into a recession. But those risks may be worth the potential reward.
