Thursday, December 1 2022

This year, the shares of Allied Financial (NYSE: ALLY) traded hands more often than usual thanks to a tacit approval from Warren Buffett. Berkshire Hathawaythe holding company that Buffett had run since 1965 opened a new position in all-digital banking during the first quarter, then significantly increased its stake during the second.

On Oct. 20, Ally Financial shares fell slightly as investors worried about the company’s somewhat negative outlook for loan repayment rates. If you’re worried that Buffett made a mistake buying shares of this bank, you may be overreacting. Here’s why.

1. Asset quality is normalizing and not deteriorating

Ally Financial, and banks in general, are currently going through a tough time due to rising interest rates, and a general economic downturn has caused these higher rates. Over time, however, wider spreads between interest paid to savings account holders and Ally’s loans will improve profitability.

Ally Financial’s share price is under pressure in part because loan quality appears to be collapsing. For example, personal auto loans that are not expected to be repaid more than quadrupled year-over-year in the third quarter. Indeed, the temporary stimulus payments Americans received in 2021 have dried up.

The rapid rise in charges is troubling, but it doesn’t look like investors need to worry too much about the quality of Ally’s assets at this time. In the third quarter, 30-day delinquencies reached 2.9%, still significantly below pre-pandemic levels.

2. It’s a good deal right now

Ally Financial shares trade at just 0.7 times the company’s book value. This is a very low valuation for a bank on relatively solid foundations.

ALLY Price to Book Value data by YCharts

For example, the actions of Wells Fargo and JPMorgan Chase both trade at prices above their book values. This is a bit surprising as the returns on equity (ROE) they generated were significantly lower than Ally Financial’s ROE.

Ally Financial’s low valuation essentially means you can buy $1 of Ally Financial stock for just $0.70. At this reverse price, the stock can outperform its peers over time even if it generates similar returns on equity.

3. Originations and deposits are up sharply

Investors should be encouraged by signs that Ally is gaining a share of the lucrative auto loan market. Vehicle sales were down 11% in the third quarter of this year compared to the third quarter of 2019. Despite this challenging environment, the company expects to generate $48 billion in consumer auto loans this year. This would be 32% more than the company created in 2019.

Finding new people to lend money to isn’t the only area where Ally excels. The number of consumers making deposits at Ally Bank increased for the 54th consecutive quarter to 2.6 million. Since the end of 2019, retail balances have climbed 29% to $134 billion.

4. Dividend payouts are growing rapidly

If you’re looking for a company that treats its shareholders well, it’s hard to beat Ally Financial. Over the past five years, the company has reduced its number of outstanding shares by almost a third.

A much smaller number of shares makes it easier to commit to higher dividend payouts and that is exactly what the company has done. Ally’s payout has increased 150% over the past five years.

With fewer shares outstanding, only 20% of free cash flow generated from operations over the past year was enough to meet the company’s dividend commitment. With such a well-funded dividend program, investors can also expect big payout increases in the years to come.

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Ally is an advertising partner of The Ascent, a Motley Fool Company. Cory Renauer has no position in the stocks mentioned. The Motley Fool has no position in the stocks mentioned. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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