This Buffett Stock Just Went on Sale. Time to Buy?

Ally Financial (ALLY 0.86%) has become the largest all-digital U.S. bank, attracting customers with its low fees and high savings rates. It’s already on many investors’ radars because it’s a Buffett stock.

Its stock tumbled last week after giving investors a disappointing update, and it might take some time to recover. Should you stay away, or is this an opportunity to buy on the dip?

All about Ally

Ally’s roots are in auto lending, starting out as the financial segment of General Motors. It became its own company in 2009 and debuted on the stock market in 2014.

Auto loans remain a significant part of Ally’s business. It’s the top prime lender in the country, and it continues to field strong application volume despite the pressured microenvironment. It also has a robust consumer lending unit. It has increased provisions for losses and adopted careful underwriting to account for risk and delinquencies, and it’s been managing through the period.

Bank business is cyclical, and investors know that when interest rates are high, banks don’t perform as well as when they’re low. High interest rates lead to defaults and lower lending activity, and banks must pay higher rates on deposits.

Until recently, Ally stock had been climbing over the past year. It has demonstrated resilience and captured consumer interest. It’s a mix of an established business that’s been around for more than a century with a modern digital platform. It was incredibly cheap when Buffett recognized its potential in early 2022, but it’s gotten more expensive as the price has risen.

Short-term blip or a long-term problem?

Despite management’s efforts to plan conservatively for higher default rates, it gave an update last week that they’ve been higher than expected. At a Barclays (NYSE: BCS) conference, CFO Russ Hutchinson said that Ally’s “credit challenges have intensified” and that auto delinquencies rose in July and August. He said that charge-off rates were worse than expected and that delinquencies might continue to expand as customers are still struggling with inflation. He added that credit card rates are in line with expectations.

Ally stock dropped 17% after the news. It’s not just the environment that’s concerning investors. Obviously, banks are under stress from the high interest rates and increased default rates. What’s more concerning is that with all of its rigorous credit approval mechanisms, it came up short and didn’t anticipate this happening. Does that point to a flaw in Ally’s system? The other major banks haven’t given the same report, but they also haven’t released third-quarter earnings yet.

Low price, high dividend

Buffett isn’t usually fond of less-than-stellar companies. That said, he isn’t perfect (nor does he claim to be), and there are a few things that could disrupt Buffett’s view of a company.

One is management. That’s always a key pillar of Buffett’s investing thesis. Good management includes succession plans, but they can change. Ally recently went through a management change, and that could impact how the company is run.

It tapped CEO Michael Rhodes, who had been expected to take over at Discover Financial Services before changing tracks and starting at Ally in April. Management changes at established banks don’t usually cue a market reaction, and they typically go smoothly, but it’s something to keep in mind as Ally fizzles right now.

The other factors that Buffett looks for in an excellent business are all still here, and the investing thesis looks intact. Ally is a consumer-facing business that plays a strong role in the economy; it’s cheap, and it pays a growing dividend.

ALLY PE Ratio data by YCharts

Its valuation had increased from dirt cheap to reasonable over the past few years, but at the current price, it’s quite cheap again. Its dividend yield is back in high territory at this price as well.

Ally stock looks like a bargain right now, but expect volatility in the near future. It could be a good time to take a small position if you have a long time horizon and are looking for a dividend stock to add to your portfolio.