Last years wasn't the best for bank stocks. Although many companies felt pressure, banks feel the impact of inflation and rising interest rates more acutely than some other companies. In general, those two conditions lead to higher default rates and hit banks' net interest income. There are positives, though, such as increases in deposits.
However, although they struggled through most of the year, bank stocks have soared since the Federal Reserve said last month that it might cut interest rates in 2024. Some bank stocks closed out the year beating the market, but there are still bargains to be had. Warren Buffett is known for his embrace of the value approach to investing, and his two favorite bank stocks these days are also incredibly cheap. If you're looking for quality value stocks, consider buying Ally (ALLY 0.41%) and Bank of America (BAC -0.21%).
1. Ally Financial: The digital banking superstar
Ally is the largest all-digital bank in the U.S. It started as the financial arm of General Motors, and it was spun off to become a separate company, but it retains a robust auto lending segment. Auto lending was still strong in 2023 despite the negative impact of high interest rates. Ally had a record 3.7 million applications, but with its effective risk-management software, it had a 30% approval rate and originated $10.6 billion in loans.
But it also offers a full suite of digital services and some of the best user experiences a customer can find in digital banking. It consistently scores high on customer satisfaction metrics, and it's been expanding in important ways.
Retail customers increased by more than 300,000 to 3 million, and deposits increased by more than $7 billion year over year in the third quarter to $153 billion. Ally has an industry-leading 96% retention rate, and as more members discover the benefits Ally has to offer, these customers provide years of revenue and income generation.
That doesn't mean there's no pressure now. Net interest income is shrinking, and return on tangible common equity has declined. The charge-off rate has increased in line with expectations. But these are short-term trends related to the cyclical nature of banking and they are consistent with industry trends.
Ally stock trades at a price-to-earnings ratio of less than 10 and price-to-book ratio of less than 1. It was even cheaper than its current price for a while, but it has gained more than other bank stocks on the positive interest rate news. That might be because it was so cheap before, or because its potential looks very strong. However, even at higher prices, it remains cheaper than most other large banks.
Ally pays a dividend that yields 3.5% at the current price, and this bank's stock could add value to your portfolio for decades.
2. Bank of America: The large consumer banking giant
Bank of America is the second-largest U.S. bank by assets, and it's been Buffett's favorite bank stock for years. That could be due to its large consumer banking division. Buffett has stated many times that he loves companies that are brand favorites and have a strong role in the U.S. economy, and BofA hits both of those check marks.
Its consumer banking division demonstrated strength in the third quarter with 200,000 new bank accounts and 1.1 million new credit cards. Consumer investment accounts increased 10% over last year, and investment account assets increased 28%. However, average deposits decreased from last year, and higher reserve build and charge-off rates led to lower net income for the segment.
As consumer banking was mixed, wealth management and investment banking are starting to become more prominent parts of the business. There was a 20% year-over-year increase in wealth management relationships and a 26% increase in business lending revenue for Bank of America. That helped drive higher total net income in the 2023 third quarter despite a higher consolidated reserve build and charge-off rate.
Bank of America stock trades at less than 10 times trailing-12-month earnings and just over 1 times book value, making it just a tad more expensive than Ally in terms of valuation. Its dividend yields 2.9%, and it's a strong candidate for a solid anchor stock in a diversified portfolio.
