If there's a short list of the most successful investors of all time, Berkshire Hathaway (BRK.A -0.76%) (BRK.B -0.69%) CEO Warren Buffett is likely to rank near the top of the list. Over more than five decades, the so-called "Oracle of Omaha" has proved his investing acumen, driving Berkshire Hathaway stock up roughly 20% annually, and delivering aggregate returns of 3,787,464%. Given these results, it isn't surprising investors scour his picks to find inspiration.
One Berkshire Hathaway stock that looks particularly attractive right now is Ally Financial (ALLY 0.41%). Even as the economy is trudging the long road to recovery, high interest rates have plagued auto financing, which is a large contributor to the bank's operations. As a result, the stock trades down roughly 51% from its peak. Yet Berkshire still owns nearly 10% of Ally's stock. Let's take a step back to see what investors could be missing.
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Not your grandfather's bank
What sets Ally Bank apart from its peers is its business model. That company doesn't operate like many of its traditional competitors, forgoing the path of traditional branches offered by most legacy banks. The company has long focused on digital financial services while still offering all of the traditional banking services of its rivals, including checking and savings accounts, certificates of deposit (CDs), and personal loans, as well as home and auto loans. The company also provides a host of investment services, business financing, and point-of-sale loans, as well as loan services for automobile dealers.
Because the company doesn't have brick-and-mortar locations, it isn't saddled with the accompanying expenses -- including staffing, utilities, and real-estate expenses. That gives Ally a significant competitive advantage, in that it can offer considerably higher interest rates than many of its peers.
The company is also known for its relentless attention to customer service, which keeps turnover low, resulting in an industry-leading 96% retention rate. (I've been a customer for years.) Ally is a 2023 award winner, earning a five-star rating from The Ascent, a Motley Fool service. This focus on the customer has also helped Ally increase its asset base to more than $161 billion in total assets and retail deposits of $140 billion.
The attraction for Berkshire
There are probably a number of things that attracted Buffett to Ally Financial. It's no secret that he's long had a soft spot for banks -- though that love affair has been strained of late. Buffett also loves a deal -- and Ally certainly checks that box -- trading for 86% of its tangible book value, which is incredibly cheap for a bank. To provide perspective, Bank of America, Berkshire's largest bank holding, trades for 1.25 times book value, which shows just how inexpensive Ally is by comparison.
Buffett is an unapologetic fan of dividends, and Ally checks that box as well. Since the company initiated its dividend in mid-2016, Ally has increased its payout by 275% and currently yields 4.36%, nearly double that of Bank of America's 2.27%.
Those attributes may have influenced Buffett's choice to hold a considerable stake in Ally, totaling 29 million shares, or roughly 9.6% of the outstanding stock, valued at approximately $798 million.
The fine print
There's little question that Ally Financial stock is cheap, but there are a number of challenges ahead. While there's been a pause in rapidly rising interest rates, there's still a narrow spread between the interest rates Ally pays its depositors and what it earns from loans. In the third quarter, Ally's net interest margin of 3.24% fell by 4% sequentially and is down 15% from the comparable prior-year quarter. Furthermore, management expects things to get worse before they get better, forecasting a full-year net interest margin of 3.3%, down from its previous forecast of 3.4%. If the Federal Reserve Bank issues another round of interest rate increases to combat inflation, additional compression is possible.
That said, recent improvements in inflation and the resulting commentary from the Fed suggest the yearslong campaign of rate increases might be nearing its end -- which would help put Ally on the road to recovery.
Economists are still split on the potential for a recession in the U.S., but if things get worse, it could spell trouble for Ally. The company's auto loan business has been plagued by elevated inflation and high interest rates, which pressured consumer budgets and Ally's auto loan business. The company currently has a provision for credit losses of $508 million, compared with $438 million in the prior-year quarter. At the same time, delinquencies 30 days or more past due rose to 3.85%, up from 2.93% this time last year, which suggests that challenges remain.
That said, Buffett wouldn't continue to hold a stake of this size in Ally Financial if he didn't believe there was an opportunity to profit from that decision -- and Wall Street seems to agree. Analysts' consensus estimates call for Ally's earnings per share (EPS) to jump from an estimated $3.16 in 2023 to $3.83 next year, a 21% increase -- though that forecast is subject to change.
Given the bargain-basement stock price, the improving state of the economy, and the growing likelihood for recovery, now is the time to follow Buffett's example and buy Ally stock before the inevitable rebound.
