This Buffett Stock Could Become a Data & Analytics Giant

How much upside potential is there for Moody’s (MCO 1.18%)? In this clip from “The Rank” on Motley Fool Live, recorded on April 25, Motley Fool contributors Jason Hall and Matt Frankel discuss the competitive landscape of the data and analytics company and whether it’s worth buying at the price it is.

Jason Hall: So Moody’s is one of three companies, along with S&P Global (SPGI 2.18%) and to a lesser degree Fitch Ratings, that are basically the de facto credit rating agencies in the U.S. So, what does that mean? Rating corporate debt, extending so companies can get credit, right? So it’s really, critically important. And for Moody’s that makes up a little more than 60% of its business. It also has a pretty robust analytics business that makes up a little less than 40% of its business. I think it’s definitely becoming more of a distant second to S&P Global in terms of scale. S&P Global just closed a merger. You gotta help me out here, Matt. What’s it called? Market Access? IHS Markit (INFO)? There we go. IHS Markit. That’s really going to make it a data and analytics giant. And Moody’s is becoming an even smaller version of that same kind of analytics and credit rating agencies. I see a couple of headwinds, right? So one, I think we’re going to see, as interest rates continue to rise, it’s going to slow credit activity a little bit in the corporate world, and that’s a little bit of a headwind but not much because its customers and a lot of its customers are institutional investors and other groups that are buying debt, and they always want the latest information as material things change about a company, right? They want to make sure if they’re buying debt that was issued two years ago that the ratings are reflected based on the business today and its ability to service that debt. But, I do think that’s a little bit of an activity headwind. Here’s the thing. It trades at a discount to S&P and probably always will, because it’s not going to be at that scale with the same kind of margins. But at the end of the day, I kind of look at this a lot like some of these larger businesses on the valuation size. The bigger a business gets and the more predictable it is, in terms of its profits and cash flows, the more valuation is important at getting and buying well. You can overpay for a small growing company. And if the company executes well, it still can work out with wonderful returns. With these bigger, more mature businesses, it’s more important to pay a reasonable valuation. And that’s why I ranked Moody’s where I did. Anybody else? 

Matt Frankel: I definitely see Moody’s as one of the wide moat businesses Buffett owns. It’s totally clear why Buffett loves it. My question is, to Jason, how much upside potential do you see in Moody’s from here? Which is kind of the reason I didn’t rank it higher, is that I see kind of limited potential for growth in that business. 

Hall: Yeah, I mean the way I think about it is, when you get to a business of this scale, and you’re providing financial services to basically a cross-section of corporate America that looks like corporate America on average, you should be able to grow your business roughly GDP, plus maybe a little bit more, right? Maybe you can take market share. Fitch is like 15% of the market. Continue to expand that data and analytics business, because a lot of money is flowing toward data, right? So you can grow that a little bit more. And then because these are high-margin operating leverage business models, more of that revenue is incremental margin, right? If you can grow your profits, you know, 8% to 12% a year, you know that’s a market average kind of return. If the market’s a little below average over a 5- or 10-year period, it’s the kind of business that can beat the market in that sort of environment. I think that’s what you’re signing up for though. And paying 28 times earnings is a pretty steep price, particularly when you’re not getting a big dividend yield as ballast on the other end. So, it’s a good business, but again you’re paying a pretty high premium for a good business that’s going to grow at an average, predictable rate right now.