Warren Buffett’s Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) recently posted its 13F, detailing all the moves it made to its $313 billion stock portfolio in the third quarter. There were a number of changes this past quarter, as several long-time holdings like General Motors (NYSE:GM), Proctor and Gamble (NYSE:PG), and Johnson and Johnson (NYSE:JNJ) were jettisoned from the portfolio.
One of the smallest positions in Berkshire Hathaway’s portfolio, Jefferies Financial (NYSE:JEF), remains, and it is poised to break out in the year ahead. Here is why this is a Warren Buffett stock to consider right now.
Improving conditions for investment banking
The past two years have been brutal for investment banks like Jefferies Financial. Through the first three quarters of 2023, the volume of mergers and acquisitions was down 27% from 2022. Additionally, in 2022, M&A deals dropped by 36% from 2021, so this has been a precipitous two-year drop. While there are several reasons, they all pretty much boil down to one thing: higher interest rates, which make deal-making less attractive.
However, there is some light at the end of the tunnel, as the investment banking market may have hit bottom. In its fiscal third quarter ended Aug. 31, Jefferies saw its investment banking revenue increase 28% from the second quarter to $645 million, although it was down about 2% year over year. However, total investment banking revenue, including both M&A and capital markets, was up 5% from the previous quarter and 10% year over year.
“We are increasingly optimistic that we have come off the bottom of the cycle and that momentum in investment banking will continue,” CEO Richard Handler and President Brian Friedman said in the earnings report.
They cited “modestly improved mergers and acquisitions activity and a more receptive leveraged finance and new issue market, as the green shoots we mentioned last quarter have multiplied,” as the reasons.
As a pure-play investment bank, Jefferies stock is prone to move with the cyclicality of the industry. However, these positive trends, along with improving conditions for investment banking and pent-up demand, indicate that the firm could be on an upswing.
Growth and expansion
While no one is expecting a return to the record number of deals seen in 2021, the investment banking market is projected to improve in 2024, as it really can’t get much worse. With interest rates likely reaching a plateau and anticipated to start moving downward in 2024, they will be a catalyst for increased activity.
There is lots of pent-up demand from deals put on hold over the past two years, so while we may not see the dam burst next year, they should start trickling out in 2024 with more to come in 2025. There should also be more consolidation in hard-hit industries, like banking, for example.
Jefferies’ stock price is up about 9% year to date, outperforming most of its competitors. It is also undervalued with respect to its future earnings expectations, with a forward price-to-earnings (P/E) ratio of 8.7 and a price-to-book value of 0.75, which means it is trading below the value of the assets on its books.
The company has been on an impressive run the past five years since it sold off piece by piece the assets from the former Leucadia National, a conglomerate it acquired it in 2012. Leucadia was a holding company not unlike Berkshire Hathaway that owned multiple subsidiaries.
Jefferies is now a pure-play investment bank, and at the end of 2022, it was ranked sixth globally in M&A deals. Further, its stock price has had an average annualized return of 11% over the past five years.
With its sole focus on investment banking, Jefferies has been expanding, with plans for 360 managing directors at the end of 2024, up from 299 at the start of 2023 and from 219 at the start of 2020. Managing directors are the ones that forge relationships and make deals, so growth in this area indicates expansion.
Buffett obviously saw the value of Jefferies when he bought it in 2022, and now its value may be even better heading into 2024. It is certainly a Buffett stock to consider.
Disclaimer: All investments involve risk. In no way should this article be taken as investment advice or constitute responsibility for investment gains or losses. The information in this report should not be relied upon for investment decisions. All investors must conduct their own due diligence and consult their own investment advisors in making trading decisions.