Following last month’s banking crisis, investors are on the prowl for bargains among financial stocks. When searching for low-priced bank stocks on a screener, Ally Financial (NYSE:ALLY) stock is likely to pop up.
Changing hands for around $25 per share today, this automotive-focused bank also trades at a sizable discount to its book value of $35.20 per share.
Ally has yet to experience severe distress, like the situation with First Republic (NYSE:FRC).
Or worse, a “game over” moment, like what transpired with SVB Financial (OTCMKTS:SIVBQ) and its Silicon Valley Bank subsidiary.
With this, value investors with a contrarian streak may believe that ALLY has become oversold. Although it is possible for mis-pricing to occur in the market, don’t assume that this is the case here.
The Truth Behind its Low Earnings Multiple
Ally Financial screens well, based on commonly used valuation metrics. Yet when you look more closely at the details, it becomes crystal clear that this bank stock is hardly the bargain that it seems at first glance. Above, I mentioned ALLY’s super-low P/E ratio.
This figure is based on the financial firm’s 2022 earnings of $5.06 per share, not on estimated earnings for 2023. The boom times for used auto financing continued to produce strong profits for Ally during the first quarter (Q1) of 2022.
Starting in Q2 of last year, the used car bubble led to increased loan delinquencies and had a negative impact on profitability.
ALLY stock, already trending lower ahead of this, experienced an extended slide. This was because of growing worries about the bank’s future prospects, as it reported quarter after quarter of earnings declines.
This trend will continue in 2023. Sell-side forecasts call for earnings of just $3.74 per share. Depending on how much auto loan market conditions worsen, earnings could come even lower than this estimate. This calls into question whether shares truly trade at a big discount to peers.
What About the Balance Sheet?
Even as I argue ALLY stock isn’t that much cheaper than other financial stocks that also trade at single-digit P/E ratios, it’s worth noting shares trade at a nearly 28% discount to book value.
However, like the earnings figure, Ally’s reported book value is also deceiving. The sharp rise in interest rates over the past year has resulted in a large amount of unrealized securities losses. As of Dec. 31, 2022, these totaled $4.06 billion, or around $13.56 per share.
This figure, relative to its book value, makes the current discount appear scant rather than sizable. Since January, interest rates have kept climbing, albeit slightly. When this bank next reports earnings later this month, this unrealized loss figure could climb higher.
Yes, Ally may not realize these losses. It may hold on to these loans until maturity. A much-awaited pivot by the Federal Reserve on interest rates could emerge, helping to lower this unrealized loss as well.
While Ally’s “paper losses” may not give you pause, the prospect of rising net charge-offs should.
Ally Financial’s management has tried to downplay the risk of further realized loan losses. For instance, it has pointed to higher interest rates on new loans as something that can help counter an expected rise in net charge-offs from 1.7% to 2.2% this year.
However, it’s not set in stone that net charge-offs only rise to 2.2% by the end of 2023.
Although Ally’s loan-loss reserves are more conservative, pricing-in the possibility of 3.6% in net charge-offs, the ultimate figure could exceed this, if there’s a severe recession.
Also, remember that Ally has high exposure to the precarious situation with Carvana (NYSE:CVNA). There’s a lot pointing to ALLY’s current valuation failing to fully account for its many risks.
ALLY stock remains a value trap situation. Bargain hunters take heed and stay away.
ALLY stock earns a D rating in Portfolio Grader.
On the date of publication, neither Louis Navellier nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in this article.