Warren Buffett, the chairman and CEO of Berkshire Hathaway, has held Moody's (NYSE:MCO) in his portfolio for 20 years, as of October. The credit rating and data analytics company is his fifth-longest-held position.
Any stock that the Oracle of Omaha has held for 20 years probably deserves your attention. If Buffett's stamp of approval alone is not a good enough reason for you to invest in this stock -- and it shouldn't be -- letʻs take a deeper dive to see why Moody's is worth an investment.
Checking off Buffett's boxes
Over the past 10 years, Moody's stock price has been on a steady ride up. From Dec. 1, 2010, through Dec. 1, 2020, the stock price has gone from about $26 per share to $279 per share for an annualized return of 28%. There are few financial stocks that have performed better and more consistently than Moody's. In that time period, there were only two years, 2016 and 2018, where the stock was down -- about 4% each time. This year, a difficult one for most stocks in the financial sector, it was up about 18% through Wednesday's close.
A major reason why Moody's has been so successful is that it encapsulates two things that Buffett looks for in his stocks -- market leadership and a wide moat. Moody's is one of only three major credit rating agencies in the U.S., along with S&P Global and Fitch. Moody's and S&P are the two largest, each with about 40% market share, while Fitch is a distant third at 15% market share. So, there are only three major players -- and it likely will stay that way. There isn't a need for any more, as too many in this space would dilute the ratings.
As Moody's rates corporate debt, its earnings are typically going to be higher when there is more debt to rate. And for the third straight quarter, there was record debt issuance, primarily refinancing and liquidity issuance, due to historically low interest rates. Overall, Moody's reported $1.4 billion in revenue in the third quarter, up 9% year over year. Moody's Investors Service (MIS), the credit rating business, saw revenue climb 11% to $825 million, while Moody's Analytics, which provides economic research, risk assessment, and consulting services, saw revenue jump 7% year over year to $531 million. Net income climbed 23% to $467 million, or $2.49 per share.
While the investor services business has been the cash cow for Moody's, the analytics arm has enjoyed significant growth and has been a great revenue diversifier. Over the last five years, revenue for Moody's Analytics has almost doubled, from $286 million in 2015.
This year, the company has made two acquisitions to bolster this side of the business. In February, Moody's bought Regulatory DataCorp, which provides data to help companies comply with anti-money laundering and know-your-customer regulations. And this month, Moody's purchased ZM Financial Systems, which provides risk and financial management software for banks.
A great buy
Moody's has been an earnings machine, with a sky-high operating margin of 47.3% at the end of the third quarter, up from 44.3% a year ago. In the MIS business, the margin is 64%, and on the analytics side it is 31%. It had $1.4 billion in free cash flow at the end of the third quarter, up from $1.1 billion a year ago. As my colleague Sean Williams pointed out recently, Moody's might be Buffett's greatest investment, as the company is doubling its investment, without reinvestment, every 4.5 years.
Credit issuance is projected to slow down in the fourth quarter and in 2021, falling short of the 16% increase we saw in 2020. Moody's will still generate strong earnings because of its market-leading position and competitive advantages. It also has the growing analytics business, which has been a steady performer and should do well as the economy starts to grow coming out of the recession.
So, if you needed further assurance beyond Buffett that Moody's is a buy, there you have it.