There's a strong argument to be made that Berkshire Hathaway CEO Warren Buffett is the greatest investor of all time. His tenure spans more than five decades, and his performance is unmatched. During his 58-year stint helming Berkshire Hathaway, the so-called "Oracle of Omaha" has helped Berkshire deliver stock price gains of nearly 20% annually, generating aggregate returns of 3,787,464%. Given his results, it isn't surprising that investors turn to him for inspiration.
One Warren Buffett stock that looks like a steal right now is Ally Financial (ALLY 0.41%). The continuing macroeconomic headwinds and high interest rates have stunted the growth of auto loans, which make up the lion's share of the bank's business. As a result, the stock is still down more than 56% from its 2021 peak. Yet Berkshire holds a stake representing nearly 10% of Ally's stock. Let's look at the evidence to see what investors might be missing.
Image source: Getty Images.
Ally is a fintech pioneer
One of the things that sets Ally apart is that it isn't constrained by the baggage carried by most legacy banks. The bank's fintech focus means nearly all of its transactions are handled online, though it offers nearly all the same services as its brick-and-mortar competitors. Its suite of traditional services includes checking and savings accounts, certificates of deposit (CDs), personal loans, mortgages, and auto loans. Ally also offers a wide assortment of business financing, investment services, and point-of-sale loans. It also offers loan services for car dealerships.
What Ally does not have is traditional bank branches, which gives the company a distinct competitive advantage. Since Ally doesn't have any of the expenses associated with maintaining physical locations -- real estate, utilities, staffing, etc. -- it can offer much higher interest on deposit accounts than its more conventional rivals.
The company's digital-only services and relentless focus on customer service have set Ally apart, and its customers sing its praises. The company boasts an 87% customer satisfaction rating and an industry-leading 96% retention rate (I'm also a satisfied customer). This has helped Ally grow a portfolio of more than $161 billion in total assets and retail deposits of $140 billion.
The draw for Buffett
There are likely a number of reasons Buffett likes Ally Financial. His longtime love affair with bank stocks is well documented, though that relationship has been strained in recent years. More importantly, perhaps, Buffett can't resist a good bargain. Ally certainly qualifies in that regard, trading for just 72% of its tangible book value, which is incredibly cheap for a bank. For context, Bank of America -- which represents Berkshire's largest bank stake -- trades for 1.15 times book value, which shows just how cheap Ally really is.
Buffett is also a big fan of dividends, and Ally excels there as well. Since initiating its dividend seven years ago, the company has increased its payout by an impressive 275% and currently yields 3.65% (as of this writing), well ahead of Bank of America's 3.34%.
The combination of a dirt-cheap stock and a sizable dividend yield may have played a part in Buffett's reasoning when he took a sizable stake in Ally Bank. Berkshire currently holds 29 million shares, or 9.6% of the stock, in a stake valued at roughly $714 million.
A no-brainer? Maybe
While there's no question that Ally stock sells for a song, there ain't no such thing as a free lunch, as the saying goes. The rapid increase in interest rates has weighed on the company's results, as the spread between what the company pays to depositors and what it earns from loans narrows. In the third quarter, Ally's net interest margin (NIM) of 3.38% was down about 4.3% sequentially and down 13% compared to the prior-year quarter. This ongoing contraction eats into Ally's profits.
Furthermore, management is increasingly pessimistic about the rest of 2023, forecasting a full-year margin of 3.3%, which could worsen if interest rates go any higher. However, in a speech given just this week, Federal Reserve Chair Jerome Powell suggested the Fed might keep rates steady when it meets again in November but left the door open to additional rate hikes if the situation dictates. An end to the long series of rising interest rates would mark the beginning of the road to recovery for Ally.
Then, there is the potential for a recession. Current economic headwinds and high interest rates are rattling the car-buying market, which in turn puts pressure on Ally's auto lending business.
Consumer budgets are already stretched to the breaking point, pressuring Ally's auto lending segment. The company currently has a provision for credit losses of $508 million, up from $438 million in the prior-year quarter. Furthermore, delinquencies 30 days or more past due rose to 3.85%, up from 2.9% this time last year, which illustrates the precarious position of consumer budgets.
That said, Buffett's no fool, and he wouldn't hold a 10% stake in the company if he didn't think things would turn around -- given time. Wall Street seems to agree with that assessment. Analysts' consensus estimates call for Ally's earnings per share (EPS) to jump from an estimated $3.24 in 2023 to $4.11 next year, an increase of 27%. If the economy contracts again or slips into recession, however, Ally's recovery could be put on hold.
On balance, however, given the potential for an improving economy and its bargain basement stock price, now is the time to buy Ally stock and put it in the "hold forever" pile.
