For all the concerns about inflation, COVID-19 variants, and the effect of investments in infrastructure and social programs, the overall stock market has had a very good year -- with the S&P 500 up about 23% year to date. But not all segments of the market are up, and many stocks that soared to ridiculously high valuations during the pandemic have come back to earth.
Market downturns can be hard on investors, but they can also offer good buying opportunities. Then there are some stocks that don't need a downturn to bring down their valuation -- they are already cheap.
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Here's one dirt cheap stock with major growth potential that many investors have overlooked -- Jefferies Financial Group (JEF +2.22%).
Record revenue in the third quarter
Jefferies Financial Group is a New York City-based investment bank that serves the middle market -- generally deals below $1 billion -- where it is one of the more prominent players. It also has capital markets, merchant banking, and asset management businesses, but investing banking accounts form the bulk of its revenue. Roughly $1.2 billion of the $1.9 billion in net revenue in the third quarter came from investment banking.
The company has been firing on all cylinders, with revenue up 19.9% year over year in its third quarter ended Aug. 31 -- a record for the third quarter. Net income for the quarter increased 33.9% year over year to $407.5 million. Through the first three quarters of the year, revenue is up 53% to $6.4 billion.
The gains in the most recent quarter were fueled by record revenue in Jefferies Group, the investment banking business, which brought in $1.2 billion -- up 100% over the prior-year quarter. The advisory business did $584 million in revenue, while equity underwriting generated $367 million and debt underwriting posted $229 million -- all record amounts. Through the first nine months of the year, investment banking revenue is $3.25 billion, which is double from the previous year.
"In this most recent quarter, we completed more investment banking transactions (up 18% this quarter from Q3 2020), with more clients (up 19%), at a greater average value per transaction (up 48%) than ever before," CEO Rich Handler and President Brian Friedman said. Overall, Jefferies Group arranged 424 transactions for 407 different clients with an aggregate deal value of $238 billion in the quarter.
Gaining market share
Jefferies' success stems from focusing on its core business, investment banking, as it has sold off other businesses gathered from acquisitions over the years and is exiting its merchant banking business. The company invested heavily in its people, technology, and operations in its investment banking business for the three years leading up to the pandemic, and those investments are starting to pay off with increased efficiency and productivity.
The improved efficiencies can be measured by a return on equity that has climbed to 17%, which is the highest level in at least a decade, and an operating margin of 25.5%, which is the highest since 2018.
As an investment bank, Jefferies has improved its market share from No. 17 in 2010 to eighth in 2021 in terms of revenue. In global mergers and acquisitions, it ranks No. 6. Overall, investment banking at Jefferies has grown at a compound annual rate of 27%, compared to 4% for the industry since 2020.
Growth at a good value
With a record amount of backlog in the fourth quarter, Jefferies should have continued success heading into 2022. But longer-term, Jefferies has been expanding its coverage, adding 20% more managing directors (MDs) in 2021 for a total of 270 at the end of the year.
Not only are they adding MDs and expanding coverage, but the MDs have increased productivity, with revenue per MD doubling over the past five years. The company has bolstered its coverage in the financial, healthcare, and industrial sectors, in particular. It has also expanded globally, with plans to expand into Spain, United Arab Emirates, and Israel, among other places, next year.
While Jefferies is gaining brand recognition in investment banking, it has not garnered as much attention from investors. The stock price is up 55%, yet it remains undervalued with a price-to-earnings ratio of 6.4. It is currently trading below book value, with a price-to-book value of 0.91. Wall Street analysts project a consensus price target of $51 per share over the next 12 months, which would be a nearly 34% gain from its current level.
As Handler said at Jefferies Investor Day in October, this is a "company that is in the very early stages of being recognized in terms of value." Investors may want to take note.
