Last week, the Federal Reserve indicated that it will keep pushing the pause button on interest rate hikes, and that it expects to cut interest rates next year. That's been cause for celebration on Wall Street, where high interest rates weighed on many stocks last year. The S&P 500 is rallying, and it's up 24% as we close out 2023.
Interest rate trends affect bank stocks more acutely than others, and bank stocks have been surging on the news of moderating inflation, a receding chance of a recession, and interest rate stability. But one bank is moving higher than others, and you might be surprised to learn which one.
A top Buffett stock
The bank stock that has been outdoing its peers is Ally Financial (ALLY 0.41%). Warren Buffett's holding company Berkshire Hathaway owns 9.6% of Ally, although it accounts for a tiny fraction of the Berkshire Hathaway portfolio.
During the past month, Ally stock rose 27%, a bigger gain than other, larger banks like JPMorgan Chase, Bank of America, Capital One, Wells Fargo, and Citigroup.
Ally is the 21st-largest U.S. bank by assets, and it's a little different from the bigger banks in a few ways.
For one thing, it's all digital. It offers an easy-to-use platform with high rates that it can pull off because it doesn't have to pay for expensive real estate. This simple, modern approach resonates with customers who have become digital-savvy and enjoy the ability to bank online easily and without fuss. Ally is the largest all-digital bank in the U.S.
But there are other parts of Ally's business that are unique. It has a large auto-lending segment, which was its original business and is still a major growth driver. This segment has been performing well despite the high interest rates that deter some people from borrowing. Even so, Ally reported a record 3.7 million auto loan applications in the 2023 third quarter, with $10.6 billion in originations.
There's been some narrowing in the bank's net interest margin -- the difference between what it earns on loans and other assets and what it pays for deposits -- and income as Ally still carries older loans with lower rates. Total deposits increased by $7 billion year-over-year in the latest quarter to $153 billion, and this has been increasing consecutively for 14 years.
Why Ally?
Based on that, investors might see the bigger picture when thinking about how Ally can capitalize on this digital opportunity.
For instance, Ally is far from the largest U.S. bank by assets -- that distinction goes to JPMorgan Chase. But it did have the largest relative increase in cash recently.
ALLY Cash and Equivalents (Quarterly) data by YCharts
It's drawing new customers to its platform who are making larger deposits, and it's using that money to fund auto loans and create a positive cycle. More than that, it demonstrates that Ally has something going for it that customers like. As it attracts a millennial cohort, these customers will grow with it and provide fresh opportunities for continued growth for decades.
And let's not forget the dividend. Ally's dividend yields 3.5% at the current price. That's more than double the S&P 500 average, and is the second-highest of the banks on this list, behind only the struggling Citigroup.
Is Ally stock a buy?
Ally stock was trading at an incredibly low valuation for a while and looked severely undervalued compared to its peers. Ally's price-to-earnings ratio and price-to-book value have both increased along with the share rise, and it no longer has the same dirt-cheap valuation as before. However, this is a trend that has occurred at all of the banks on this list -- all have seen valuation gains recently. Against that backdrop, and compared with other banks, this Buffett stock still looks like a bargain.
More importantly, Ally is well positioned to benefit from interest rate cuts when they come, which should lead to higher net interest income and and a wider net interest margin. The company has a long growth runway as it captures young consumer market share, and that's what investors are seeing right now.
