IIn its recently released 13F regulatory filing, which shows the stocks a company bought and sold in a given quarter, Warren Buffett’s conglomerate Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B) unveiled a new stake in digital consumer banking Allied Financial (NYSE: ALLY). Berkshire bought about 8.97 million shares in the first quarter of 2022 for a total value of nearly $390 million. Berkshire’s average cost was around $43.48 per share.
Ally is by no means a large position for Berkshire and represents only a small fraction of the holding company’s nearly $347 billion equity portfolio. But the move is interesting nonetheless, given that Berkshire sold off so many of its other bank holdings in 2020 and 2021. Should you invest alongside Buffett and Berkshire in Ally? We’ll take a look.
Meet Ally Financial
Ally is the largest direct-to-consumer digital bank in the United States, with more than $184 billion in assets under management at the end of the first quarter of this year, making it the 23rd largest bank in the United States. in terms of assets, according to the FDIC.
Ally has no physical branches and is focused on meeting many consumer financial needs. It is primarily active in the auto loan business, but also has a large mortgage loan portfolio and offers personal, credit card and point-of-sale loans. Ally also owns an insurance business, an online brokerage and wealth management division with nearly $17 billion in client assets, and offers automotive commercial lending and corporate financial services.
Ally has benefited enormously from the automotive boom that began in the wake of the pandemic and which has driven up vehicle prices, especially in the used car sector. In the first quarter of 2022, Ally issued $11.6 billion in retail auto loans from 3.2 million applications, the highest level of origination the company has seen in the first quarter in 11 years. The portfolio’s average return was also strong, exceeding 7%. The increased activity in the automotive space has also spilled over into other areas of Ally’s business.
This increased activity has helped Ally achieve a return on tangible equity (ROTCE) of over 24% in 2021, essentially more than double any other ROTCE Ally has generated since its IPO in 2014.
A classic Buffett piece
Similar to Berkshire’s purchase of Citigroup stock in the first quarter, Ally looks like a classic Buffett value play. The stock is cheap at about 110% of its tangible book value, which is essentially the net worth of a bank. Ally shares are also trading at around 5.2 times forward earnings. Both of these valuations are very cheap for a company that just produced a 24% ROTCE.
But of course there is a reason for the reduction. As high levels of inflation persist and the Federal Reserve aggressively raises interest rates, driving up the cost of debt, the market worries about consumer financial health, especially if the economy tumbles into a recession.
This could lead to more loan losses in Ally’s auto portfolio and other consumer loan portfolios. Over the past five quarters, the auto assembly portfolio has had a weighted average FICO score above 680, which is prime borrowing. The bank has built a reserve coverage ratio for its auto portfolio of 3.49%, meaning it currently reserves enough capital to cover losses on 3.49% of its auto loan portfolio. Defaults and loan losses are both below 0.60% of the total auto loan portfolio, but are expected to normalize and increase.
The other thing that makes Ally a classic Buffett game is the fact that it has a strong dividend yield of nearly 2.7% and buys back a lot of stocks. Since 2016, Ally has repurchased more than 32% of its outstanding shares and also plans to repurchase $2 billion worth of stock this year.
Should you invest?
I agree with Buffett and Berkshire that Ally presents a very solid risk-reward opportunity. The business is in much better shape than it was before the pandemic, not only because of the auto boom, but also because Ally has a core deposit base and customer base. overall much better than before. Ally management knows that conditions will normalize in terms of credit and auto loans, and they are also preparing for lower used vehicle prices.
Despite the normalization, Ally is still targeting a mid-term ROTCE between 16% and 18%, which is a much better return than Ally has ever generated before the pandemic. The company also continues to reward its shareholders with a strong dividend and numerous share buybacks.
There is the risk of being exposed to the consumer, who could end up in a recession at some point, but as with Buffett and Berkshire, I think Ally stock is worth at least devoting a small portion of your portfolio to.
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Citigroup is an advertising partner of The Ascent, a Motley Fool company. Ally is an advertising partner of The Ascent, a Motley Fool company. Bram Berkowitz has positions in Citigroup and has the following options: long January 2024 $90 calls on Citigroup. The Motley Fool holds positions and recommends Berkshire Hathaway (B shares). The Motley Fool recommends Fair Isaac and recommends the following options: $200 long calls in January 2023 on Berkshire Hathaway (B shares), $200 short put options in January 2023 on Berkshire Hathaway (B shares) and short calls of 265 $ in January 2023 on Berkshire Hathaway (B shares). ). 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.