Coming into 2022, Berkshire Hathaway was sitting on its biggest cash pile on record. The conglomerate has used the bear market to snap up stocks, and one stock that Warren Buffett and his team added in the third quarter was the investment bank Jefferies Financial Group (JEF 0.34%).
Investment banking has faced an uphill challenge in the past year, but it didn't deter Buffett from investing. Jefferies exhibits traits in common with other Buffett stocks, including a dirt cheap valuation and a fortress balance sheet. Read on to find out why Jefferies is an ideal Buffett stock -- and whether it's right for you, too.
Investment bankers faced headwinds in 2022
Jefferies Financial Group provides investment banking services to clients, helping them with mergers and acquisitions (M&A), going public through initial public offerings (IPOs), and issuing debt. The investment banking industry saw deal activity plummet last year following a record year of dealmaking in 2021.
The investment banking business slumped in the past year as geopolitical uncertainty, inflation, and rapid increases in interest rates caused companies to put deals and offerings on hold. According to data from Renaissance Capital, there were 71 IPOs last year, with proceeds of just $7.7 billion, a drop of 82% and 95%, respectively. Data from Refinitiv showed that M&A deals were down 36% in comparison -- the largest drop since 2001.
Here is what makes Jefferies an ideal Buffett stock
In the third quarter, Berkshire Hathaway disclosed that it purchased 433,558 shares in Jefferies worth about $12.8 million at the time. It's a tiny position, and it's possible that Berkshire began building its stake near the end of the third quarter and continued to add to it during the fourth quarter.
Investment banks have fallen far since 2021, and it's likely this pessimism attracted the attention of Buffett and his team. In the third quarter, Jefferies traded at a price-to-tangible book value (P/TBV) as low as 0.73, giving the stock a margin of safety for Berkshire Hathaway.
The margin of safety is a concept used by Buffett that looks at the difference between the intrinsic value of a stock and its current price. When a stock gets as cheap as Jefferies is, its upside outweighs the downside potential, making the investment less risky in theory. For much of 2022, Jefferies traded below its 10-year average P/TBV of 0.94.
Another aspect to like about Jefferies is its fortress balance sheet. In its most recent earnings release, for the period ended Nov. 30, Jefferies had more than $9.7 billion in cash and cash equivalents. The bank used its strong cash position to return $1.14 billion to shareholders, including $280.1 million in dividends (its dividend yield is about 3%) and $859.6 million to repurchase its stock.
Over five years, Jefferies has returned $5.5 billion in capital to shareholders through dividends and share repurchases. It recently announced the spinoff of Vitesse Energy, which will generate another $500 million in cash for the investment bank.
What to expect from Jefferies
Jefferies saw earnings decline this past year, with investment banking revenue down 32%. Of this total, underwriting revenue, which comes from IPOs and debt issuance, was down 59%, while advisory revenue, which comes from M&A, debt restructuring, and other transactions, was down 5%.
On a positive note, the firm has taken market share and is moving up in the investment banking league rankings. Last year Jefferies ranked as the seventh largest investment banking firm across its core businesses, moving up from 10th in 2017.
Investment banking will likely face more headwinds in the first half of 2023, but a moderation in inflation and a stabilization in interest rates could bode well for the industry in the second half. Some in the industry expect the size of the investment banking business to stay above pre-pandemic levels -- which could bode well for Jefferies as it continues expand its investment banking presence.