Do you want to become richer? Buy this Warren Buffett dividend growth stock as the Fed cuts interest rates.

It finally happened. The Federal Reserve just cut interest rates by 50 basis points (0.5% in percentage terms). Investors rejoiced, sending S&P 500 to new all-time highs. The stock market is now up 100% over the past five years, driven by rising earnings and the artificial intelligence (AI) boom, despite the Fed taking interest rates from zero to 5% two years ago.

However, not all companies are at their best. Come in Financial ally (ALLY -1.37%). The consumer bank and auto lender have faced deposit cost headwinds from rising interest rates, which are now beginning to reverse. That’s why Ally, which is among several bank stocks owned by Warren Buffett’s Berkshire Hathaway, is a perfect buy, and the Fed is now cutting interest rates.

Battling interest rate headwinds

Ally’s goal is to disrupt consumer banking with an online-only bank that offers depositors consistently high interest rates. It has kept that promise and delivered brilliantly over the past decade: it currently has $142 billion in retail deposits. It consistently pays higher interest on savings accounts compared to the big banks, which is why it can win customers from the likes of Bank of America. Ally currently offers depositors a 4.2% annual return on parking money with it.

Deposits are the fuel a consumer bank uses to make loans, which is how it makes profits. Ally makes the majority of its loans in the consumer auto market, driven by its relationship with US auto dealers. These loans typically last several years and are based on the Fed interest rate and the yield on US Treasuries at the time. issuing the loan.

This was a problem for Ally when the Fed quickly raised interest rates to fight inflation. Why? Because in order to maintain its attractiveness to depositors, the bank had to rapidly increase the interest paid on deposit accounts. Ally’s blended cost of interest on deposits was 4.21% last quarter, compared to 0.77% in the second quarter of 2021. That was a huge cost at the same time as the average loan book yield grew more slowly. If the auto loans have a term of about three years, the loans made in 2021 and 2022 are still on Ally’s balance sheet, which were made when the interest rates were zero.

Rising interest rates have compressed the margin Ally earns on deposit costs against the return on loans it makes, which is known as net interest margin (NIM). As the Fed lowers interest rates, this headwind will slowly diminish and help Ally’s earnings grow.

Lower interest rates help both sides of the business

When the Fed lowers interest rates, it helps Ally in its consumer business. In the banking industry, interest rates paid to depositors will fall, lowering part of the NIM equation.

As for the loan, it will also help Ally. First, yields on the existing loan book will not fall as fast as deposit rates, helping the other side of NIM. Second, lower interest rates mean Ally can offer car buyers lower interest rates on auto loans. This will help consumers more easily afford their cars and make them more likely to repay their loans in full. Ally cited increases in auto delinquencies in recent quarters, which may hurt profits. Lower interest rates will hopefully reduce the risk of this trend worsening.

ALLY Dividends per share (TTM) data by YCharts.

Buy this stock for dividend growth

It’s clear that lower interest rates will help Ally Financial’s profitability. And yet, this recovery doesn’t seem to be priced into the stock, which is why I think now is a perfect time to buy dividend growth stocks and hold for the long haul.

Today, Ally has a market cap of $10.5 billion. In the last 12 months, it generated $823 million. Just a few years ago, the bank was generating nearly $2 billion in net income. Once its NIM recovers, its earnings will begin to move back to these previous levels.

That earnings growth should fuel Ally’s dividend growth, which has risen 275% since the bank began making payments in 2018. At a current yield of 3.5%, investors still get a profitable entry point today high. That makes the Warren Buffett bank an easy buy for dividend growth right now.