By Matt Doiron
Financial ratings agencies suffered severe hits to their reputations in the late 2000s financial crisis, having contributed to the problem by assigning high ratings to mortgage-backed securities that were then treated as low-risk assets. Yet, they are back in the news again as global economic uncertainty - particularly in Europe - has raised the question of sovereign defaults and made upgrades and downgrades of sovereign debt major market news. Investors can't invest directly in Standard & Poor's and Fitch, so Moody's Corporation (NYSE:MCO) offers investors an opportunity to own shares in a ratings agency.
The company recently issued its 10-Q for the second quarter of 2012, reporting earnings per share of 76 cents as opposed to 82 cents in the second quarter of 2011. Thanks to a strong first quarter, however, Moody's has seen a slight increase in earnings per share in the first half of the year. Revenue for the first half is up 9%, which has been led by growth in the smaller Moody's Analytics. This business unit engages in non-rating commercial activities such as risk management services. The ratings business did see small growth in revenue - led, as might be expected, by the public, project, and infrastructure finance business line - as well as in operating income. Out of all of Moody's business lines, the one experiencing the most growth is the very small professional services unit.
Sell-side analysts think that business at Moody's is coming back even as actual returns seem flat. The company has a trailing P/E ratio of 16, which is fairly reasonable, and a forward P/E of 14, meaning that the stock would qualify as a value play if these growth expectations can be achieved. On average, Moody's has narrowly beaten earnings expectations over the past four quarters, and medium-term expectations have recently been revised upward. After posting its earnings, the stock rose and is now up about 16% for the year.
Buyers of Moody's following this momentum are in good company: Warren Buffett's Berkshire Hathaway reported owning 28.4 million shares. Buffett doesn't appear to have bought or sold any shares in over a year, indicating that the legendary investor believes it is a good long-term buy-and-hold stock. Another 13F filer who reported a large position in the stock was ValueAct Capital, managed by Jeffrey Ubben. ValueAct is also a long-term owner but increased its holdings by 50% in summer 2011. Renaissance Technologies, owned by billionaire Jim Simons, had 1.6 million shares at the end of March. There have been insider sales at Moody's, with Chief Risk Officer Richard Cantor selling some shares that had been in his 401(k) plan pursuant to a 10(b)5-1 trading plan in March. He sold these shares at a slightly higher value than the current market price.
The McGraw-Hill Companies (MHP) owns competing ratings agency Standard & Poor's, with the company preparing to spin off its textbook- and education-related businesses. McGraw-Hill is slightly lower-priced compared to Moody's: it has a trailing P/E of 15 and a forward P/E of 13, and given the advantages of investing in spinoffs, it might be a better buy as management becomes more focused on what are now very different business units within the company.
Moody's former parent Dun & Bradstreet (NYSE:DNB) offers risk management and enterprise solutions and so still makes a good comparable company. It saw strong earnings growth in its last fiscal quarter compared to the same period in the previous year and trades at lower multiples than Moody's with a trailing P/E of 13 and a forward P/E of 10. Considering that this company has higher growth and that the division of Moody's more similar to it has been outperforming the ratings business, we would say that Dun & Bradstreet is a better buy.
Larger information provider Thomson Reuters (NYSE:TRI) is unprofitable on a trailing basis and carries a 5-year PEG similar to Morningstar's (NASDAQ:MORN). We would avoid it. Comparing Moody's to a company whose products is ratings for a different set of investment opportunities (mutual funds in this case), Morningstar has seen recent earnings growth similar to Moody's, but is priced at multiples between 24 and 30. Even over a 5-year period, which might capture longer-term growth, Morningstar comes in at a higher PEG ratio than either Moody's or Dun & Bradstreet.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.