There Are Way Better (And Cheaper) Financial Plays Than Ally Stock

ALLY looks cheap here but the financial sector offers other opportunities as well

Ally Financial (NYSE:ALLY) is cheap. Ally Financial trades at 0.82x book value, suggesting a discount to its net asset base. A 7.2x multiple to 2019 consensus EPS estimates makes ALLY stock cheap on an earnings basis as well.

Ally Bank
Source: Ally Financial

And it’s not as if Ally Financial is a declining business on either metric. Adjusted tangible book value per share, according to the company’s Q4 earnings release, rose from $28.10 to $29.90 in 2018. Adjusted EPS soared 40% last year as well. Obviously, U.S. tax reform helped profit growth, but even that aside, ALLY earnings are growing nicely.

The combination of a growing business and multiples that suggest declines going forward would seem to make ALLY a stock a buy – and maybe a screaming buy. But, as is often the case with ‘cheap’ stocks, there’s a catch. Many stocks in the financial sector have similar profiles (if not quite to the same extent). And most of those plays don’t have the same key risk that Ally Financial stock does.

The Case for Ally Financial Stock

The fundamental case for ALLY is reasonably easy to make. First, ALLY is cheap. The stock trades at a discount to adjusted tangible book value (the sum of its assets less its liabilities).

Minor adjustments are made for intangible assets and OIDs (original issue discounts) which reflect the discount to par at which Ally issues bonds. A 1x multiple just to tangible book would suggest 16% upside for Ally Financial stock.

Similarly, earnings multiples suggest room for upside as well. Even an 8x multiple to earnings moves ALLY up over 10% – plus a 2.6% dividend. However an investor views Ally Financial, the fundamental case seems reasonably strong.

The U.S. Financial Sector

All that said, it’s worth pointing out that the valuation assigned Ally Financial stock isn’t that out of line in the financial sector. Bank of America (NYSE:BAC) and JPMorgan Chase (NYSE:JPM), my two favorite bank stocks, trade at less than 10x forward earnings. BAC stock trades at just 1.14x book value (JPM admittedly is higher on that metric, at about 1.5x.)

ALLY is cheaper than those big banks, admittedly. But other lenders have similar profiles. Synchrony Financial (NYSE:SYF) and Capital One Financial (NYSE:COF), too, trade at about 7x earnings. COF actually is a cheaper on a price-to-book value, at 0.75x.

Peer valuations don’t necessarily negate the bull case for ALLY. There’s still potential upside from current multiples in terms of both assets and profits. But it’s worth remembering that in year ten of a U.S. economic expansion, financials on the whole are not going to get market-level multiples.

ALLY is highly unlikely to trade at 1.5x book or 15x earnings any time soon. And there’s a key risk that, at least for some investors, might suggest the current discount even to other “cheap” financials should persist.

The Automotive Exposure

There are two reasons that the big worry for ALLY is its heavy automotive exposure. First, Ally could see earnings fall sharply if and when the economy turns and consumers start missing car payments. This is, after all, the former financing arm of General Motors (NYSE:GM), a company that went bankrupt during the financial crisis.

The obvious worry is that Ally Financial will struggle more in a recession than a more diversified provider like BofA. That worry (again, in year ten of an economic expansion) is why lenders like ALLY, COF, and SYF are cheaper than most traditional banks.

But there’s another issue here too. Even without a recession, the concern is that demand is going to slow simply because automotive demand is going to slow. There’s a reason stocks like GM and Ford Motor Company (NYSE:F) trade at similarly cheap multiples. That reason is the fear of “peak auto.”

In that context, ALLY earnings could decline even without macro jitters or consumer weakness. Ally simply is likely to write less auto loans going forward, as cars last longer and urban populations lower demand. Ally has other businesses, but automotive finance drove 83% of pre-tax income in 2018. There’s an enormous reliance on what should be a declining automotive financing industry.

ALLY Stock Is Cheap for Good Reason

None of this is to say that ALLY is a short. But there are reasons why the stock is cheap. Financials on the whole are being discounted owing to cyclical fears (one reason the sector pulled back so sharply in December).

And a look at auto stocks shows why investors are cautious toward Ally’s heavy exposure to that industry.

In that context, it’s tough to get too excited about ALLY stock. That’s particularly true with other financials pulling back yet again on Fed moves this week. Ally Financial stock very well might go up. But if it does, better plays like BAC, JPM – and maybe even F and GM – will do  the same.

As of this writing, Vince Martin has no positions in any securities mentioned.


Article printed from InvestorPlace Media, https://investorplace.com/2019/03/better-financial-plays-than-ally-stock/.

©2019 InvestorPlace Media, LLC