Ally Financial (ALLY 3.38%) became a standalone company in 2014 when it was spun off from General Motors (GM 5.73%). This is actually pretty important because it speaks to Ally Financial’s business model of making auto loans. And, after efforts to diversify the all-digital bank, it is getting out of businesses where it doesn’t have material scale or a competitive advantage. Will that turn it into a millionaire-maker stock or does it make Ally Financial too risky for most investors?
What does Ally Financial do?
At its core, Ally Financial is a bank. But it isn’t your typical bank, which is highlighted by the fact that it was once the auto finance arm of General Motors. Today, Ally Financial’s product offerings include auto loans, insurance, basic banking, credit cards, investments, and mortgage lending. So, from a big-picture perspective, it is just a typical diversified bank.
Image source: Getty Images.
However, that top-level view doesn’t do justice to the underlying story. Ally claims to be one of the top prime auto lenders, with relationships with more than 22,000 auto dealers. (Prime simply means it is focused on higher-quality auto loans.) This makes sense given the company’s history, but it has resulted in a loan portfolio that is heavily tilted toward auto loans. In 2023 roughly 58% of its loans were in the auto market, which is exceptionally high relative to most other banks.
Further, having been spun off from GM, Ally Financial also has a heavy reliance on a small number of auto brands. General Motors and Stellantis (STLA 2.64%) accounted for about 80% of Ally Financial’s new vehicle dealer inventory financing in 2023. Those two partners made up nearly 45% of the company’s overall consumer automotive financing volume. Again, that makes sense given the company’s origin, but it highlights the fact that Ally Financial isn’t your typical bank.
Ally Financial is shifting gears
At one point Ally Financial was working on diversifying its business. That is why it offers products and services outside of auto lending. However, it doesn’t really have material scale outside of the auto sector, which is why it is in the process of shutting its mortgage operations and is reportedly seeking buyers for its credit card business.
These aren’t inherently bad decisions, given that Ally Financial is basically getting out of smaller businesses that were probably more of a distraction than a benefit. However, the end result will be an even less diversified operation. If the auto industry faces problems, such as a slowdown in sales, Ally Financial will feel the impact more than other banks. Also, if default rates on auto loans tick higher for some reason, such as a recession, Ally Financial will feel it to a greater degree than its banking peers. Then there’s the material dependence on just two automakers, which would hit Ally Financial directly if demand for GM or Stellantis brands cools off.
ALLY data by YCharts
In other words, there is a material concentration risk here that investors have to consider when assessing an investment in Ally Financial. There’s opportunity here, too, however. The bank has an investment grade rated balance sheet and an opportunity to expand its reach in auto lending. So slimming down could lead to long-term growth and turn Ally Financial into a millionaire-maker stock. The well-above-market 3.3% yield is attractive compensation, too.
Is the risk worth the reward?
The truth is that Ally Financial isn’t likely to turn into a millionaire-maker stock overnight. It will likely require a long-term commitment from investors to see that happen. Between now and that potential outcome there will likely be bumps in the road that could be very difficult to live through. Rising defaults, slowing auto sales, or difficulties at GM or Stellantis could all lead to near-term performance problems and frayed nerves for shareholders.
For most investors a more diversified bank will probably be a better option than Ally Financial. But if you believe that this auto-focused lender can, over time, leverage its unique business model to expand and grow, it could be worth owning. Just make sure you are ready for the volatility that such a concentrated business is likely to experience or you may abandon ship before you benefit from the potential growth here.
Ally is an advertising partner of Motley Fool Money. Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool recommends General Motors and Stellantis and recommends the following options: long January 2025 $25 calls on General Motors. The Motley Fool has a disclosure policy.
