There is a funny thing about record quarters. Sometimes the earnings report tells you exactly what happened. Other times, it tells you which part of the report everyone is looking at.
Jefferies Financial Group (NYSE:JEF) just produced its best-ever investment-banking quarter, pushed quarterly net revenue to $2.22 billion and generated $1.08 in diluted EPS. Equities revenue hit a record $626 million, while investment banking reached $1.33 billion, and the stock sits around $46.50.
But that doesn’t make the quarter bad. Investment banking really is booming, equities had a monster quarter, and Jefferies is benefiting from a capital-markets environment that has opened up considerably. But walking the numbers from revenue to profit, from profit to returns, and finally to what management did with shareholder capital leaves five contradictions underneath the “record” label.
1. Record Revenue, Almost No Improvement In Returns
Jefferies increased quarterly net revenue from $2.05 billion to $2.22 billion, an 8.5% increase, while net earnings attributable to common shareholders climbed 16% to $261 million. Adjusted diluted EPS rose from $1.01 to $1.08. Yet return on adjusted tangible shareholders’ equity was 13.5%, versus 13.6% a year ago. That’s almost no movement after the business just produced its strongest investment-banking quarter ever.
Adjusted tangible book value per fully diluted share also increased from $33.38 to $35.21, meaning Jefferies is generating more revenue while supporting the business with a larger tangible-equity base.
For a financial company, revenue growth eventually has to show up in the returns earned on the capital behind it. Jefferies hasn’t produced that improvement yet.
2. The Revenue Boom Is Getting More Expensive
The people producing that record investment-banking revenue are taking a larger piece of it. Compensation and benefits increased to $1.19 billion, roughly 10% above last year, against 8.5% revenue growth. Compensation therefore consumed 53.7% of net revenue, up from 52.9%. That is the economics of a human-capital-heavy investment bank showing itself. When advisory and underwriting explode, the bankers generating those fees become more valuable too, and some of that incremental revenue follows them into compensation.
So the problem isn’t that 53.7% is catastrophic. It is that the ratio moved higher during a quarter that was supposed to demonstrate operating leverage. Revenue grew 8.5%. Compensation grew faster. And that leads directly into the next contradiction, because the additional revenue isn’t translating into pretax profit at the same pace.
3. EPS Looks Better Than The Operating Business
Pretax income increased just 5.8%, from $331.8 million to $351.0 million. Net earnings attributable to common shareholders, however, jumped roughly 16%, from $224.0 million to $260.6 million. The tax provision fell to $87.0 million from $89.3 million, allowing more of the pretax income to reach the bottom line. So the EPS number is improving considerably faster than the underlying operating profit.
That doesn’t make the $1.08 figure meaningless either. But I’d rather see the pretax earnings start catching up before treating the EPS growth as evidence of a much more powerful earnings engine.
4. The “Record” Quarter Has A Very Specific Shape
Investment banking produced $1.33 billion of revenue, with advisory at $817.8 million, equity underwriting at $305.5 million and debt underwriting at $177.1 million. Equities contributed another $626.2 million, up roughly 29% year over year. Then fixed income went the other way, falling to $176 million from $237 million.
Asset-management net revenue fell even harder, from $176.8 million to $85.6 million, with Jefferies citing lower management and performance fees and weaker performance across several strategies. This is what the record quarter actually looks like when you stop looking at the aggregate number: dealmaking and equities are firing, while fixed income and asset management are pulling in the opposite direction.
That isn’t unusual for an investment bank. M&A and underwriting can create enormous fee pools when markets open, while other businesses lag. The problem for Jefferies is proving that the strength in its best businesses can become durable enough to carry the weaker ones when the capital-markets cycle eventually cools.
5. Jefferies Bought Its Own Stock Much Higher
The shareholder-return table adds another wrinkle. Jefferies repurchased 1.3 million shares for $70 million during Q3 at an average of $52.54 per share. Over nine months, it bought back 8.3 million shares for $441 million at an average of $53.25. JEF is now around $46.50. So the company spent hundreds of millions buying its own shares around $53 while the market has since marked those purchases down by roughly 13%.
I wouldn’t call that automatically wrong. The buyback reduced the share count, and management was making those decisions with the information available at the time. But the price action makes the decision worth examining alongside the stagnant ROATE and rising compensation ratio.
The chart has also broken its rising trendline, with JEF below the $50.15 20-day SMA and the $52.88 50-day and 200-day averages. Those are the levels I’d want to see the stock reclaim before treating the stock’s decline as disconnected from the earnings story.
For now, I’m sitting on the sidelines of the “record” headline. Jefferies has earned the right to call investment banking revenue a record. But it hasn’t yet shown the same improvement in return.
