Following the start of the pandemic in 2020, Berkshire Hathaway (BRK.A -0.07%) (BRK.B -0.07%), the large conglomerate run by legendary investor Warren Buffett, didn't waste any time in disposing of its stake in the investment banking powerhouse Goldman Sachs (GS -0.75%).
Following the sale, the move looked to be a massive mistake, as all of the market volatility boosted Goldman's business through the roof in 2021 thanks to elevated sales and trading to equity and debt underwriting. Berkshire's decision looks to be a little better this year as underwriting activity has significantly declined, although Goldman's stock remains well above pre-pandemic levels.
But now Buffett seems ready to dip his toe back into the investment banking business. In the third quarter, Berkshire disclosed in a regulatory filing that it has taken a very small stake in the much smaller investment bank Jefferies Financial Group (JEF -2.24%). Let's take a look at what Buffett and the rest of the Berkshire team are thinking here.
A small stake in a growing sector
To be sure, Berkshire's new stake in Jefferies is tiny, so small I'm confused why the conglomerate is even bothering at all unless it purchased shares at the end of the third quarter and has continued to do so in recent months. Berkshire purchased 433,558 shares, which at the time amounted to nearly $12.8 million. That makes Jefferies one of the smallest positions in Berkshire's massive roughly $344 billion equities folder.
Image source: Motley Fool.
While the investment banking business is struggling this year, many expect that the actual size of the business, or the total fees available in a given year, known as the size of the wallet, is actually going to be bigger than it was prior to the pandemic.
Daniel Pinto, the president and COO of JPMorgan Chase (JPM 0.11%), another stock Berkshire dumped during the pandemic, noted at a conference in September that the size of the wallet between 2011 and 2019 would usually fluctuate between $70 billion and $85 billion. It was $79 billion in 2019, then it jumped to $95 billion in 2020 and a whopping $123 billion in 2021 before falling to what Pinto thinks will be around $70 billion this year. Over a longer period of time, Pinto believes the size of the wallet could normalize around 2020 levels, which are significantly higher than the norm.
Pinto also believes trading is going to continue to perform at a much bigger scale than it has in the past. In 2019 the size of the wallet for trading was about $160 billion. Over the last three years, it's been between $200 billion and $215 billion, a range that Pinto expects to hold going forward.
Gaining market share
Jefferies is a good deal smaller than some of the investment banking giants like JPMorgan Chase and Goldman Sachs. For instance, in Jefferies' most recent quarter ending Aug. 31, the bank generated about $681.8 million in total investment banking revenue. Meanwhile, for the quarter ending Sept. 30, JPMorgan generated more than $1.7 billion, while Goldman had $1.58 billion.
Jefferies CEO Richard Handler said in the company's recent earnings statement that "Investment Banking and Equities were very resilient, and we expect we have gained market share in those areas as we continue to support our clients through this volatile time."
Jefferies' investment banking revenue fell a whopping 44% year over year. But that could actually be worse when you consider the drop in the size of the wallet, and that some competitors have reported even bigger declines. Equities trading revenue is actually up year over year and from the prior quarter as well.
Additionally, Jefferies performed well in the third quarter in certain pockets. It had 119 U.S.-announced deals where it served as the financial advisor, making it tied for fourth. It also performed very well in U.S. middle market deals, where it came in second and third in transaction value and number of deals, respectively.
Getting in at a good valuation
Buffett and Berkshire still seem pretty cautious about pure-play investment banks, given their small position in Jefferies. But they clearly like how Jefferies has been performing and its valuation. The bank currently trades just above tangible book value, or its net worth, and also offers an annual dividend yield in excess of 3%.
Jefferies is another bank value investment that Berkshire has begun to make more of this year along with its purchases of Citigroup (C -0.82%) and Ally Financial (ALLY -1.94%). I'll definitely be curious to see if Berkshire adds to its position in Jefferies in the current quarter.
