Are you considering a new position in Ally Financial (ALLY 0.41%)? It's not a crazy idea. The stock's dirt cheap right now, priced at less than ten times its trailing-per-share earnings and less than 9 times its profits projected for the year ahead. The dividend yield of 3.5% isn't too shabby either.
Before taking the plunge, however, there are four things you might want to know. The good news? They're not all necessarily problems.
Four things you need to know about Ally Financial
If you're reading this, then you're probably already familiar with the company. If not, Ally Financial is an online bank. While it may not offer the higher-level banking services that often require visits to physical branches, it does offer basic banking services like checking accounts, credit cards, and loans. It also allows its customers to access a nationwide network of third-party ATMs. As a consumer, you could very easily get all the banking services you'll ever need from Ally Financial.
As an investor, however, that's not necessarily enough to buy a stake in the company. While the world is increasingly open to the idea of purely digital banks, like any other business, this one's got its unique pros and cons. Four of them stand out among the rest right now.
1. Most of its business is automobile financing
Although it can offer a wide range of traditional banking services, know that most of the company's business comes from automobile loans. It produced $377 million worth of pre-tax operating income through its automotive finance arm during the third-quarter of last year versus only $84 million worth of corporate-lending income and a mere $26 million in mortgage-related pre-tax profits. This disparity has been the norm for as long as Ally's been in existence. In fact, it was launched as an auto lender. You used to know it as GMAC, or the lending arm of General Motors.
It's not an inherently fatal flaw. It does leave the company subject to the ebbs and flows of the automobile market though, which is proving particularly volatile at this time thanks to rising interest rates and steep inflation, which are being countered with consumers' sheer need for new vehicles.
2. Charge-offs are on the rise
To this end, Ally's charge-offs (or write-downs) are on the rise.
This isn't entirely surprising. Most consumers are feeling pinched by higher prices and borrowing costs right now. The Federal Reserve reports nationwide credit card debt reached a record-breaking $1.08 trillion as of the third quarter of 2023 as consumers scramble to cover their ever-rising costs. In this vein, credit card delinquencies hit a multidecade high of nearly 3%. More specific to Ally, Fitch Ratings reports there were more borrowers behind on their car payments as of last year's Q3 than there have been since the mid-1990s. It would be odd if Ally Financial wasn't suffering from consumers' struggles.
The numbers: As of Q3, Ally's overall net charge-off rate as a percentage of its loan portfolio hit 1.31%. That's the highest it's been in years. Ditto for overall net charge-offs. Its provisions for future loan losses are also on the rise, although they're not yet reaching its pre-pandemic peak.
Data source: Ally Financial. Chart by author. Loan-loss provisions and net charge-offs are in millions.
These write-downs of course reduce overall profits even if they don't require actual cash outlays.
3. The dividend is still well covered by earnings
That being said, Ally's bottom line is holding up better than you might think. It's even holding up more than well enough to continue supporting the online bank's dividend payments.
The chart below tells the tale. Even with earnings being dragged down to only $0.88 per share during Q3, that's still more than enough to fund the current quarterly-dividend payment of $0.30 per share. In fact, the current payout ratio of less than 40% of profits is a bigger cushion than several other, better-grounded and longer-lived dividend-paying companies can boast.
ALLY Normalized Diluted EPS (Quarterly) data by YCharts.
Investors should keep an eye on Ally Financial's shrinking earnings. As it stands right now, however, the dividend payment isn't in any immediate jeopardy. The overall economy may well firm up before it becomes a problem by improving the quality of the company's loan portfolio.
4. Wall Street isn't exactly stoked by Ally stock
Last but not least, although analysts don't hate the stock, they're not quite in love with it either. Most of them rate it as a hold, while the consensus price target of $34.61 is actually a tad below Ally stock's current price.
This is a bit of a two-edged sword.
On the one hand, it's a worry. If analysts don't see any apparent upside, investors may not be willing to step into a position in the company. There's just not enough perceivable reward...at least not right now.
On the other hand, this current lack of bullishness sets the stage for robust bullishness in the future. If and when Ally Financial starts beating expectations, there's lots of room for analysts to upgrade the stock and raise their price targets. This will doubly benefit existing shareholders, first by virtue of the company's solid results and second by the fact that Wall Street is seeing enough new promise to draw investors' attention to it.
Timing of course is everything. Even if upgrades are in the cards, it's difficult to know when that tailwind might begin blowing.
Every investment has some risk -- you just have to weigh it
So is Ally a buy, or a sell? On balance, the four key points made above aren't overwhelmingly bullish. The company is facing challenges to be sure, including one that could make its situation worse before allowing it to get better. That's the deterioration of the quality of its loan portfolio, which is chipping away at earnings that support the stock's dividend. If your portfolio needs more certainty, Ally stock may not be your best bet right now.
If you've got an appetite for a little risk though, this ticker is worth considering. Just be sure to keep it on a fairly short leash, respecting all of its unique risks.
