After what was a pretty disappointing 2023 for investors, in recent months, Ally Financial (ALLY 0.41%) has been on an absolute tear. Shares are up about 45% since the start of November.
Maybe investors are starting to forget about the regional banking fiasco earlier in the year. Moreover, the prospects of a more accommodative Federal Reserve in 2024 could be boosting market sentiment.
Is this digital bank stock a smart buy right now? Here are some important things investors should know that will factor into the decision.
Taking care of shareholders
One of the best things about this business is just how shareholder-friendly its capital allocation policy is. Ally Financial's current quarterly dividend of $0.30 per share is nearly 4 times higher than it was just seven years ago. And the yield sits at a hefty 3.4% today.
Additionally, Ally's management team is constantly focused on reducing the share count outstanding through buybacks. In the last five years, from the third quarter of 2018 to Q3 2023, the business repurchased 28% of its own stock. The positive effect on earnings per share can be huge.
Ally is able to do such a wonderful job of returning capital to shareholders because it has seen steady growth in areas where it matters most. The company's customer base has increased now for 58 straight quarters.
And perhaps more impressive, the business's deposit base keeps expanding. As of Sept. 30, Ally had $153 billion of deposits, up 5% year over year. This provides the bank with a sticky source of capital that can be used to fund auto loans, which are its bread-and-butter product.
Should these trends continue, dividends and share repurchases will remain a big part of Ally's investment story in the years ahead.
Ally is sensitive to economic fluctuations
Despite the positive qualities, there are some reasons to be concerned. At its core, Ally is still a bank. And this makes it vulnerable to the whims of the broader economy. In other words, the company is cyclical.
The issue with being a cyclical business is that it relies on favorable economic conditions for its success. And these factors, like interest rates, unemployment, or consumer confidence, are completely outside of its control.
Ally's net charge-off rate has increased in at least the last four quarters, a negative trend to pay attention to. And the company's net interest margin continues to shrink due mainly to much higher rates paid on deposits that it uses to fund loans. This is a serious headwind in the near term.
The bear case is compelling
Even considering the fact that Ally, like its banking peers, is a cyclical operation, investors might still want to jump on the bandwagon and buy the stock. That's because after aggressively hiking interest rates, the Federal Reserve could reverse course and implement multiple cuts in 2024. This can lead to higher loan demand from borrowers, as well as lower rates being paid to depositors, meaning more net interest income.
The strategy of buying cyclical stocks like Ally right before the economy is about to get on a stronger footing, and selling right before a downturn occurs, seems like a very smart idea. However, it's almost impossible to successfully time the market on a consistent basis. So I view this strategy as a losing proposition.
I also don't like how dependent Ally is on a single product -- auto loans, which make up 45% of total earning assets. Factors like car prices, interest rates, gas prices, and supply chain issues can all have an impact. The possibility of a negative development in the industry worries me.
Even though this bank stock trades at a price-to-earnings ratio in line with its trailing-10-year average, which signals that it's reasonably valued, I'm not planning to buy any shares. I think the risks outweigh the positive factors with Ally Financial.
