Cheapest Stock in Buffett’s Portfolio: 51% Upside?

If you’re following Warren Buffett’s investment strategies, you may have come across Ally Financial, one of Berkshire Hathaway’s more recent holdings. Despite a challenging 2022, this financial services company boasts several attractive features. In fact, by our calculations, it’s currently the cheapest stock in Buffett’s Berkshire Hathaway portfolio.

Ally Financial is an industry leader in online banking and auto lending, which caught the eye of Buffett. He has since become one of the company’s largest shareholders (he owns a 10.05% stake, which equates to 30 million shares).

Ally has a long history, dating back to 1919 when it first opened as a division of General Motors. As the company continued to grow, so did its offerings. Throughout the 1980s and 90s, it began offering loans to home buyers. By 2001, the company reached a major milestone of $1 trillion in financing. In 2010, Ally Bank rebranded as Ally Financial, and transformed its auto loan segment into Ally Auto.

In 2014, Ally Financial completed its Initial Public Offering. Despite a 5.3% increase in shares since the company’s stock went public, it took a significant hit this past year, falling by nearly 47%. Higher funding costs and rising interest rates have affected the company’s net interest margin, but there are many reasons to remain optimistic about Ally’s future prospects.

Ally Financial Is Expanding Its Offerings

Ally plans to capitalize on its strategic opportunities by expanding and diversifying its flagship auto, insurance, and digital banking platforms through the introduction of new product solutions.

While the company has a focus on automotive lending, it is not limited to just that. The bank also offers a variety of services such as the Ally Credit Card, Ally Invest and Ally Lending.

In the future, the company plans to focus on growth in areas such as corporate and mortgage finance, wealth management, insurance, and point-of-sale lending.

Buying Ally Could Be a Brilliant Move

Despite facing some near-term challenges such as rising auto loan charge-offs and thinning profit margins, Ally has the potential to provide significant returns for investors who are willing to take a chance. The company may face difficulty in growing during economic downturns, but it has strong fundamentals that should enable it to bounce back when the economy improves.

The company served 10.5 million customers and generated $8.4 billion in adjusted total net revenue. However, its Q1-Q3 2022 results were not as strong, with earnings decreasing across the board.

These declines were not unexpected; Ally has been operating in a challenging environment. The economy and interest rates were not favorable and this led to a rise in used car prices, which benefited Ally initially. But as the bubble burst, vehicle sales dropped. Price declines followed and charge-offs ballooned.

On the plus side, shareholders currently receive a healthy quarterly dividend of $0.30 per share, which is 4.4% as of this writing.

Is Ally a Buy?

Used car prices are anticipated to fall further, which will in turn reduce loan volumes. Additionally, a mild recession in 2023 coupled with rising interest rates and a narrowing net interest margin may pose challenges in the coming quarters. However, this could also present optimal buying opportunities for investors.

When we ran the numbers we found Ally to be a compelling buy on a valuation basis. We identified fair value at $39.42 per share, representing 51% upside at the time of research.