A High-Quality Growth Play With Warren Buffett Backing

Moody’s enjoys a strong competitive positions and has solid near-term growth prospect

By Blue Chip Portfolios

Summary

• Moody’s shares have proved an excellent investment over the past decade
• The company enjoys strong competitive advantages due to limited competition
• The stock has been a longtime holding of Warren Buffett’s Berkshire Hathaway
• I view the stock as attractive at current levels

Shares of Moody’s Corporation (MCO, Financial) have come under selling pressure lately amid concerns of a broader economic slowdown. The stock has been a long-time holding of Warren Buffett and has delivered excellent long-term results for shareholders. Over the past 10 years, Moody’s shares have delivered a total return of 412%. Comparably, the S&P 500 has delivered a total return of just 224%.

The company is a high-quality business with strong competitive advantages. Moreover, Moody’s also has above market growth prospects for the foreseeable future. I believe the stock represents an attractive high quality growth investment opportunity at current levels.

Company Overview

Moody’s operates two business segments: Moody’s Analytics and Moody’s Investor Services. The Moody’s Analytics segment, which accounts for roughly 47% of total revenue, provides data intelligence and analytical tools to businesses and individuals. The Moody’s Investor Services segment, which accounts for the remaining share of company revenue, provides credit ratings, research, and risk analysis. While the revenue contribution from the company’s two segments is similar, Moody’s Investor Services is a higher margin business with Adjusted Operating Margins of 60.1% compared to 30.7% for Moody’s Analytics.

Moody’s Analytics is primary a recurring revenue business (roughly 95% of revenue is recurring) as the company charges customers for access to data and tools based on a subscription model. Moody’s Investor Services is primarily a transaction driven revenue business (roughly 73% of segment revenue) as the key driver of revenue for this segment is fees paid by issuers in exchange for a credit rating. Moody’s has been in business for more than 115 years and operates globally. While the U.S. and Europe account for the bulk of the company’s revenue, it also has significant operations in Asia.

High-quality business with strong competitive advantages

The high-quality nature of Moody’s business can be seen in that it generates high returns on invested capital and enjoys a wide moat around its business. The strength of Moody’s business begins with its credit ratings business. Moody’s along with S&P Global and Fitch dominate the global ratings business. The big three are estimated to have a combined market share of roughly 95% with Moody’s and S&P each accounting for an estimated 40% of the market. While Moody’s competes with S&P and Fitch, many companies choose to be rated by more than one agency which gives Moody’s a strong degree of pricing power despite competition from S&P and Fitch. Evidence for the company’s pricing power can be seen in the roughly 60.1% Adjusted Operating Margin enjoyed by its Moody’s Investor Services segment.

The company’s Moody’s Analytics segment also enjoys strong competitive advantages due to its unique and vast data sets which allow it to offer unique insights and data solutions for clients. For context, Moody’s has more than 556 million economic, financial and demographic time series and has data on more than 525 million public and private entities. Despite this massive amount of data, Moody’s continues to enhance its data capabilities and recently announced plans to acquire CAPE Analytics to enhance its property risk analytics capabilities. Moody’s significant amount of data on public and private entities is only possible due to the special access to information it enjoys to many entities because of its position as a ratings agencies. In this sense, Moody’s two segments work together to enforce the company’s overall competitive advantage.

Long-time Buffett holding

Buffett’s Berkshire Hathaway has been a holder of Moody’s since it received shares following a spin off from Dun & Bradstreet in 2000. Berkshire’s initial position was worth roughly $499 million. Buffett reduced Berkshire’s Moody’s stake in 2009 and 2010 which proved a rare mistake for the investing legend as the stock has continued to perform quite well. Moody’s shares have delivered a total return of 1,870% since the start of 2011 while the S&P 500 has delivered a total return of just 475%.

Buffett has noted that Moody’s is a wonderful business due to its capital light nature, limited competition, and significant pricing power. Currently, Berkshire owns roughly 27.7 million shares of Moody’s which is worth roughly $11.7 billion at current prices. Moody’s is Berkshire’s 7th largest holding accounting for roughly 4.4% of its public equity portfolio. While Buffett has said little about Moody’s of late, the fact that he has continued to hold onto the shares will sharply reducing other holdings such as Apple and Bank of America can be viewed as a vote of confidence in the company.

Valuation is reasonable relative to growth prospects

Moody’s has attractive near-term growth earnings growth prospects due to increasing demand for financial data, a growing credit ratings market due to the proliferation of global debt markets, pricing power due to its strong competitive position, and a reduction in shares due to an expected $1.3 billion worth of share repurchases in 2025. AI has also become a key tailwind for Moody’s as it has increased the value of its data offerings in that AI driven solutions require significant data to be useful. Moreover, the company has also started enabling GenAI within a number of its products. Consensus earnings currently call for Moody’s to grow EPS at annual rates of 13%, 12.3%, and 11% during FY 2025 – 2027 respectively. I view these estimates as somewhat conservative given the company’s near-term growth drivers and guidance for low-to-mid teens EPS growth over the medium-term.

Shares of the stock currently trade at 31x consensus FY 2025 EPS. While this represents a premium to the 21x forward earnings that the S&P 500 currently trades at. I believe Moody’s valuation premium is well deserved as its near-term growth prospects are stronger than the broader market which has historically delivered high single digit earnings growth. Additionally, near-term growth for the broader market is heavily dependent on the AI theme which I view as significantly less predictable than the factors driving Moody’s near-term growth.

In addition to trading at a reasonable valuation relative to the broader market, Moody’s is also trading at a reasonable valuation relative to its own historical norms. Over the past 10 years, the stock has traded at an average P/E ratio of 32x. Moreover, Moody’s valuation is reasonable compared to its closest peer S&P Global which trades at a forward P/E ratio of 28x. While S&P Global trades at a slight valuation discount to Moody’s it also has modestly lower near-term growth prospects as consensus estimates call for S&P Global to deliver EPS growth of 9.6%, 11.9%, and 11.8% over the next three years.

Moody’s current valuation also appears reasonable compared to other high quality financial services stocks. Visa, which is expected to grow EPS at annual rates of 12.4%, 12.9% and 12.8% over the next three years, currently trades at 29.5x consensus forward EPS.

Risks to consider

One risk to consider is that economic conditions deteriorate resulting in challenges for the financial services industry more broadly. As a result, Moody’s customers might decide not to invest in new solutions and attempt to reduce spending on Moody’s data analytics capabilities. However, such a scenario would take time to have a material impact as customers tend to be locked into longer-term contracts. Perhaps the more significant near-term impact related to an economic slowdown would be a drop in corporate credit bond issuance which could significantly impact Moody’s transaction revenues. That said, I do not see such a scenario as highly likely in the near-term as corporations are likely to take advantage of any drop in interest rates related to a macro slowdown to refinance debt at lower interest rates.

Conclusion

Moody’s is a company with a track record of delivering excellent results for shareholders. The company benefits from a capital-light business model, limited competition, and a wide moat around it business. The stock has been a longtime holding of Buffet’s Berkshire Hathaway and remains one of its largest holdings. While Buffett has not increased this position of late, he has continued to hold while reducing a number of his other top holdings.

Moody’s has above average near-term growth prospects and trades at a moderate valuation premium to the broader market. I view this premium as appropriate given the strength of Moody’s business and solid near-term growth prospects. The stock also trades at a reasonable valuation relative to peers and other high quality financial services companies with similar growth prospects. For these reasons, I view Moody’s as an attractive investment at current levels.