Credit rating agency Moody’s just posted second quarter earnings that beat consensus estimates. Is it a buy?
One of Warren Buffett’s favorite stocks, Moody’s (NYSE:MCO) had a wild rise on Tuesday after reporting its second quarter earnings results.
The leading credit ratings agency beat consensus revenue and earnings estimates and had strong year-over-year gains in the quarter. Revenue climbed 22% year-over-year to $1.8 billion while net income soared 46% to $552 million, or $3.03 per share.
However, the stock price was quite volatile post earnings, dropping from $450 per share at the opening bell to a low of $440 shortly thereafter, before surging to $456 per share in the afternoon, up about 1%. The stock price is up about 16% year-to-date (YTD).
It didn’t appear to be anything specific to Moody’s that drove the stock lower initially, as it was likely just moving lower with the overall market after the opening bell.
Once investors looked at Moody’s Q2 numbers, they were pleased with the results as the stock moved higher.
Why is Buffett such a fan of Moody’s?
Moody’s is a top 10 holding in Warren Buffett’s Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) portfolio and he has owned it since 2000. There are only two stocks that he has held longer, Coca-Cola (NYSE:KO) and American Express (NYSE:AXP).
The primary reason is the moat around its business and earnings. Moody’s is one of those rare businesses that is a dominant player and market leader in an indispensable industry, credit ratings, with limited competitors. There are only three major credit rating agencies —Moody’s, Standard & Poor’s Global (NYSE:SPGI), and Fitch Ratings — and the barrier for entry is extremely high, so it is unlikely to see any new competitors emerge any time soon.
Revenue from the credit rating business, called Moody’s Investors Service (MIS), is its bread-and-butter, providing a steady stream of subscriber and fee income as the largest player in a very small arena. In the second quarter, it generated $1 billion in revenue, up 36% year-over-year. In the first half of the year, revenue is up 35% to $2 billion.
This has been an active period for credit issuance, but there are periods when there is less activity.
But what also makes Moody’s such a great company is that it has a secondary business called Moody’s Analytics, where it is one of the leaders in providing organizations and institutional investors with market data, analysis, and intelligence. This is a fast-growing business that often surges when markets are down, providing excellent balance alongside MIS, which typically thrives when markets are up.
In the second quarter, Moody’s Analytics generated a robust $802 million in revenue, up 7% year-over-year. In the first half, it made $1.6 billion in revenue, up 8%.
Beating the S&P 500, raising its guidance
The strength of Moody’s business has enabled it to generate market-beating returns over time. Over the past 10 years, it has posted an annualized return of 17.4%, and over the past 5 years, the annualized return is 17.6%. Currently, Moody’s stock price has returned 16% YTD, which speaks to its consistency.
The company also raised its guidance for the full year, now calling for revenue growth in the low teens, up from the previous range of low single digits to low double digits. This is based in part on its projections for a 20% to 25% increase in credit issuance in 2024, up from the previous expectations of a mid to high single digit rise.
Its outlook for EPS is also higher, now in a range of $9.95 to $10.35 per share, up from a $9.55 to $10.15 per share range. In addition, it raised its guidance for free cash flow to $2.0 billion to $2.2 billion, from $1.9 billion to $2.1 billion.
Should you buy?
Moody’s is not cheap, with a P/E ratio of 49 and a forward P/E of 41. Its valuation is as high as it has been since 2016, so investors should keep an eye on that.
Overall, Moody’s is a great stock that is highly recommended as a long-term hold, but investors may want to look for a dip or more attractive entry point before jumping in.
