Ally Financial (ALLY -0.36%) hasn't performed all that well for investors in recent years. Since April 2019, shares have generated a total return of 51%. This performance seriously lags the broader S&P 500, which isn't an encouraging trend. Most of that return for this bank stock has come in the last six months, as the share price is up 47% during that stretch.
What is encouraging is that investors appear to be warming up to Ally Financial again. Should you follow this momentum and buy shares today?
To help answer that question, I think it's a valuable exercise to understand both a key bull and bear argument regarding Ally Financial.
Bull case: Ally's deposits keep growing
Ally is the leading digital bank in the U.S., which means it doesn't have a sprawling network of physical branches scattered across the country. In a world where the internet, technology, and data are becoming increasingly important, this distinction might be an advantage. This is especially true when it comes to attracting new deposits.
Ally's savings product offers an annual percentage yield of 4.25%. That's significantly higher than the national average. Being able to control its overhead costs by not having bank branches allows the business to pay higher savings rates to consumers.
Why is it so important to continue growing deposits? For a banking entity, these funds are usually the cheapest source of capital. Other sources of cash come from capital markets debt, usually carrying much higher interest rates. Plus, deposits are incredibly sticky, demonstrating the high switching costs that banks benefit from.
Consequently, this provides Ally with the resources to continue fueling the asset side of its business, such as its credit cards and other lending products.
As of Dec. 31, the business had $140 billion of retail deposits on the books. That figure was up 5% from 12 months prior, and it marks the 14th straight year of growth. That's definitely a positive trend.
Bear case: Ally is overly exposed to one industry
On the other end of the investing spectrum, there's an important bear case that prospective investors can't ignore when it comes to Ally's business model. That's its heavy reliance on the automotive industry.
It's worthwhile to take a step back to learn some history first. Ally was created in 2010 after the Great Recession to spin off General Motors' financing unit. In other words, the business's sole focus at the time was to underwrite auto loans.
This is still prevalent today. Almost half of Ally's loan book is represented by auto loans and leases. And more than 40% of its auto loans come from GM and Stellantis dealership locations, creating distribution concentration as well.
When interest rates are lower, the used car market is robust, and demand from borrowers is strong, Ally can find itself in a very advantageous situation. This is what happened in 2021 when revenue and earnings soared.
The problem, however, is that Ally has zero control over any of these macro and industry-related variables. And in unfavorable times, the company's financials take a hit, as they did in 2023. This cyclicality is something that makes me want to avoid the stock.
Other factors to consider
For those daring investors who are unfazed by Ally's macroeconomic sensitivity, the company's dividend yield of 3.1% is a meaningful source of return. The quarterly per-share payout went from $0.08 in late 2016 to $0.30 in January this year, a solid track record of increases. Executives have done a good job at aggressively repurchasing shares.
But Ally's valuation isn't as compelling as it was just a few months ago. The stock trades at a price-to-earnings ratio of 12.8, which is about 30% higher than its trailing 10-year average. In my opinion, this is another convincing bear argument that I believe holds more weight than the bullish cash. Therefore, I'm still avoiding buying shares.
