In the past five years, the S&P 500, including dividends, produced a total return of about 100%. That's a very admirable result that investors who pick single stocks should try to outpace.
Unfortunately, Ally Financial (ALLY 0.41%) has come up well short of this mark. If we include dividends, its shares have returned just 67% since March 2019. But the stock has surged 38% so far this year, so there appears to be a growing sense of optimism.
Should investors buy, sell, or hold this bank stock? To provide some clarity, I think it's best to analyze both sides of the aisle before coming to a conclusion.
The case for buying and holding
Ally stands out in the crowded financial services industry because it's the leading digital bank in the U.S. Despite not having any physical bank branches, which can help keep overhead costs in check, Ally counts 11 million customers, indicative of its scale.
This digital business model hasn't prevented Ally from offering a range of services, like checking and savings accounts, brokerage products, and loans. This creates cross-selling opportunities, and the number of Ally customers who use multiple products has more than tripled in the past four years.
It's very encouraging to see a bank continue to increase its deposit base because this provides a low-cost source of funding that companies can use to originate more loans with. As of Dec. 31, Ally had $142 billion of retail deposits on its balance sheet, which was up more than 3% year over year. It's worth noting that because there are no branches, Ally can offer savings rates that are much higher than the average bank.
While Ally hasn't made for a terrific investment in the past few years, as I mentioned above, investors will appreciate management's favorable capital allocation policy. The business currently pays a 3.2% dividend yield, and the quarterly payout has increased steadily in the past eight years.
Ally also consistently buys back its own stock. The share count outstanding was reduced by more than 4% just in 2023. This can boost earnings per share for existing investors.
The case for selling
Like other banks, Ally's business is extremely cyclical. Changes in interest rates are particularly influential when it comes to a bank's success. This might add too much risk for some investors.
Ally reported net income of $1 billion in 2023, which was down 40% from the year before. Rapidly rising rates paid on deposits pressured the net interest margin, something that wasn't offset by charging borrowers higher rates. And thanks to increasing defaults, Ally is forced to set more capital aside to cover losses.
It's not a surprise, then, that the arrival of interest rate cuts by the Federal Reserve would be welcome news for the banking industry. However, it's anyone's guess when this will actually happen.
Not only does Ally need to wait for improving macro trends to put up better financials, but it also relies on a more robust backdrop in the automotive industry. A whopping 45% of the company's leases and loans are represented by retail auto-related financial products. The status of supply chains and car prices can have a profound effect on Ally's results. These are totally outside of the business's control.
It also doesn't help that 43% of auto loan activity in Q4 came from General Motors and Stellantis dealerships. So, there's clearly also customer concentration here.
Owning a company that experiences cyclicality, while having heavy exposure to a single industry and product, might be enough of a reason to pass on the stock. In fact, this is how I view the situation. I believe the bearish arguments are more compelling than the bull case.
