In the third quarter of the year, Berkshire Hathaway (BRK.A -0.25%) (BRK.B -0.33%), the large conglomerate run by legendary investor Warren Buffett, opened a small stake in the investment bank Jefferies Financial Group (JEF -2.20%).
It was the first pure-play investment bank Berkshire has invested in since dumping Goldman Sachs (GS -1.38%) shortly after the pandemic started. However, the small position shows that Buffett and Berkshire still have some reservations about the industry, and perhaps rightfully so.
For its fiscal year 2022, Jefferies generated diluted earnings per share of $3.06, down about 50% from its fiscal year 2021. Should investors be worried? Let's take a look.
The industry is struggling
In 2021, the investment banking industry had a sensational year. Companies took advantage of meteoric valuations to go public in droves, and there were lots more mergers and acquisitions (M&A) as well.
Image source: Getty Images.
But those times are long gone, as volatile market conditions and lower valuations have depressed deal volume. Investment banking performed even worse for Jefferies in the fourth quarter than it did in the third quarter, with total investment banking revenue falling another 25%, led by big quarterly drops in M&A advisory and equity underwriting. In the fourth quarter, total investment banking revenue fell a whopping 71% year over year. Usually, there is a boost in M&A to close out the year, but Bloomberg recently reported there was no Q4 boost for the first time in four years.
On a more upbeat note, however, Jefferies also has a large sales and trading business, which rose on a quarterly and year-over-year basis in Q4. These businesses tend to perform better in more volatile market conditions, as investors are constantly repositioning, and Jefferies enjoyed a nice year in the business. Jefferies' asset management business also had a nice year, with total revenue in fiscal 2022 up 15% year over year.
Taking market share
The difficult thing about investment banking is that the industry can be limited by the external environment, as we saw this past year. Also, keep in mind that fiscal year 2022 was always going to be a tough comparison, given how strong the industry was the previous year.
But Jefferies did pick up market share in 2022, which is important in investment banking. In the fourth-quarter earnings release, Jefferies CEO Richard Handler and President Brian Friedman said Jefferies ranked No. 6 for global M&A and global equity capital markets, which is up from their rankings of 12 and 13, respectively, five years ago. Competitors ahead of Jefferies are also much larger institutions.
Jefferies also continues to return strong levels of capital to shareholders. The bank repurchased $121 million of common stock in the fourth quarter, and the board of directors has increased the company's share repurchase authorization to $250 million. Jefferies also continues to have an annual dividend yield in excess of 3%.
The investment bank has now distributed $5 billion of capital to shareholders through repurchases and dividends, which is equal to two-thirds of Jefferies' tangible common equity at the beginning of 2018.
Should shareholders be worried?
While investment banking and total profits slumped in 2022, most shareholders expected it at this point, as dealmaking has really taken a hit in these market conditions. I expect dealmaking to gradually rebound as the year progresses.
In the meantime, Jefferies has been returning capital to shareholders, including repurchasing shares while the stock trades below or around its tangible book value, or net worth, which will reward shareholders on a long-term basis.
Jefferies also seems to be picking up market share in several of its key businesses, so it looks like this new Buffett stock is headed in the right direction.
