Ally Financial currently trades at $42.33 per share and has shown little upside over the past six months, posting a middling return of 3.9%. The stock also fell short of the S&P 500’s 10% gain during that period.
Is now the time to buy Ally Financial, or should you be careful about including it in your portfolio? Get the full breakdown from our expert analysts, it’s free.
Why Do We Think Ally Financial Will Underperform?
We're sitting this one out for now. Here are three reasons you should be careful with ALLY and a stock we'd rather own.
1. Long-Term Revenue Growth Disappoints
A company’s long-term sales performance is one signal of its overall quality. Even a bad business can shine for one or two quarters, but a top-tier one grows for years.
Unfortunately, Ally Financial’s 4.2% annualized revenue growth over the last five years was sluggish. This fell short of our benchmark for the financials sector.
2. EPS Trending Down
We track the long-term change in earnings per share (EPS) because it highlights whether a company’s growth is profitable.
Sadly for Ally Financial, its EPS declined by 4.8% annually over the last five years while its revenue grew by 4.2%. This tells us the company became less profitable on a per-share basis as it expanded.
3. High Debt Levels Increase Risk
Leverage is core to a financial firm’s business model (loans funded by deposits). To ensure economic stability and avoid a repeat of the 2008 GFC, regulators require certain levels of capital and liquidity, focusing on the Tier 1 capital ratio.
Tier 1 capital is the highest-quality capital that a firm holds, consisting primarily of common stock and retained earnings, but also physical gold. It serves as the primary cushion against losses and is the first line of defense in times of financial distress.
This capital is divided by risk-weighted assets to derive the Tier 1 capital ratio. Risk-weighted means that cash and US treasury securities are assigned little risk while unsecured consumer loans and equity investments get much higher risk weights, for example.
New regulation after the 2008 financial crisis requires that all firms must maintain a Tier 1 capital ratio greater than 4.5%. On top of this, there are additional buffers based on scale, risk profile, and other regulatory classifications, so that at the end of the day, firms generally must maintain a 7-10% ratio at minimum.
Over the last two years, Ally Financial has averaged a Tier 1 capital ratio of 9.9%, which is considered unsafe in the event of a black swan or if macro or market conditions suddenly deteriorate. For this reason alone, we will be crossing it off our shopping list.
Final Judgment
We see the value of companies driving economic growth, but in the case of Ally Financial, we’re out. With its shares underperforming the market lately, the stock trades at 7.6× forward P/E (or $42.33 per share). While this valuation is optically cheap, the potential downside is huge given its shaky fundamentals. There are superior stocks to buy right now. Let us point you toward a top digital advertising platform riding the creator economy.
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