As the markets continue their upswing, there are plenty of stocks out there hitting new all-time highs. Given the general negative market sentiment just a year ago, this may have seemed unlikely, but the broad-based indexes continue to perform. The S&P 500 is now trading above 5,000 and is already up 5.4% just in 2024.
While the broader market is doing well, not all stocks have rallied to the same degree. Take Ally Financial (ALLY 0.41%), for instance. The online bank has seen some investor hesitancy over the last few quarters as investors were concerned about various regional banking sector uncertainties, rising interest rates, and the company's exposure to the less-than-favorable automotive loan market. Its largest shareholder is Warren Buffett's Berkshire Hathaway, which owns close to 9% of the company (as of Dec. 31, 2023).
Share prices of Ally Financial are off roughly 36% from their all-time highs, trading for approximately $36 a share. Is it time to buy the dip and ride with Buffett? Let's investigate further and see how cheap Ally Financial stock truly is.
Ally Financial: Not your legacy bank
Ally was born out of the Great Recession in 2008 when General Motors sold off its financial subsidiary, GMAC -- as part of efforts to get out from under a bankruptcy filing. GMAC then changed its name and began its evolution into a full-fledged consumer bank.
Its connections with many auto dealerships around the United States helped it keep its auto loan operations. Car-related loans still make up over half of the assets on its balance sheet.
The automotive-lending operations didn't drastically change when Ally Financial was formed, but it had to develop a whole new business muscle: consumer banking. Starting from scratch after the advent of smartphones, Ally made the wise decision to become an online-only bank with zero physical branches. Today, this allows the company to run with lower overhead costs and offer customers high interest rates on their checking and savings accounts.
Running this playbook has led to consistent growth, and now Ally is ranked by several organizations among the best online-only banks in the country. It has $142 billion in retail deposits, 3 million customers, and depositors that have grown consistently for more than a decade. As it grows, Ally is moving to expand its product offerings to customers, including credit cards, mortgages, and investing. Around 300,000 Ally customers are now multi-product customers, up from less than 100,000 in 2019.
Only a small sliver of the U.S. population banks with Ally, which gives it plenty of room for growth. With its proven playbook in attracting depositors to its higher-interest-rate banking products, it should be able to grow its deposits for many years into the future.
Higher interest rates aren't always a good thing
As an automotive lender, Ally hit some headwinds when the Federal Reserve raised the Fed Funds Rate from near 0% in early 2022 to 5.25% in July 2023. This rapid rise in rates adversely affected Ally's balance sheet.
Raising savings rates for new depositors while existing loans were bringing in less revenue because of their low interest rates put a strain on balances. Add to that the price of used cars starting to decline, lowering the amounts being borrowed and the salvage value of cars Ally recovered from delinquent loans. Then Ally saw more loans performing poorly, with net charge-offs on car loans rising to 2.21% last quarter, compared to 1.66% a year ago.
Add it all together, and Ally's net interest margin (NIM) between what it pays depositors and what it brings in from loans has fallen from over 4% to 3.2% last quarter. Consolidated net income fell as a result.
The Federal Reserve appears to be done with interest-rate hikes for the time being, so the worst of these headwinds is easing. Ally is guiding for NIM to be 3.4%-3.5% by the end of 2024 as its balance sheet normalizes with higher-interest-rate loans, which should lead to overall earnings growth. Eventually, it expects NIM to return to 4% or higher.
The stock looks cheap -- if you have patience
Ally generated around $1 billion in net earnings in 2023, giving the stock a P/E of around 11, based on its market cap of $10.9 billion. On its face, this looks cheap. All Ally has to do is keep earning what it earned in 2023, and the stock will likely do well for shareholders.
But forward earnings likely look a lot better than $1 billion. NIM has been compressed significantly in recent quarters and should start to widen this year. This should help Ally grow its net earnings. On top of this, Ally's fuel for making loans (deposits) has consistently grown, which will enable it to grow the size of its loan book.
Ally was earning $2 billion annually not too long ago. If it can do so again, its P/E will fall close to 5. It may take a few years to get there, but Ally stock looks mighty cheap for long-term investors at its current price below $40.
