Moody's

Moody's (NYSE: MCO).

This 107-year-old company provides ratings on fixed-income securities, debt instruments, and counterparties – corporations. Moody's covers 12,000 corporate issuers of debt and about 96,000 structured financial obligations, including things like mortgage-backed securities.  This company has offices in 22 countries and employs more than 3,000 people worldwide.

There are two keys to understanding this company's business. First, it's almost impossible to issue debt without a rating from Moody's, and the issuer must pay for the rating.  As a result, Moody's makes money both by selling information to subscribers and by selling ratings to debt issuers.
Second, Moody's has a very wide safety net because of its sterling reputation and because the government regulates these firms – the Nationally Recognized Statistical Rating Organizations.
Moody's and Standard & Poor's are widely considering the leading firms.  The following pack include Fitch, A.M. Best, and  Dominion Bond Rating Service of Canada.

Investor anxiety has recently touched all corners of the market, but there has been extra anxiety surrounding the stocks of companies involved in housing and mortgage loans. Moody's has been no exception. The market has sold the stock strongly since July 10th. I t has fallen from $76 to $45.  This is the biggest decline in share price in its entire trading history.

The market obviously believes that Moody's business will slow as the issuance of mortgage-backed securities declines.  It also fears that regulators will lay some of the blame for mortgage-security defaults at the feet of Moody's and Standard & Poor's. But, we believe both fears are overblown, especially the threat to Moody's reputation.  Moody's and its rival, Standard & Poor's,have developed expertise and reputations that bring them some 80% of the ratings business and a circle of recurring customers.
The existing regulatory framework also favors the industry's established players, such as Moody's.
In the long run, Moody's commitment to maintaining its reputation is a valuable investment in its future.

In regard to the economic risks, Moody's has proved very resistant to economic cycles, in the past.  In good times and bad, companies issue debt. For example, during the last bear market in 2002, Moody's revenues were more than $1 billion – up considerably from the boom year of 2000 ($602.3 million). In 2006, Moody's had its best year ever, with revenues topping $2 billion.  It earned $750 million in net income and produced an incredible 51% return on assets.  The company's financial results prove that its underlying business is broad-based and resilient.  For the second quarter, revenue increased to $646.1 million, a 26%  increase over the previous year.  Earnings per share reached $0.95, a 31% increase excluding a tax benefit that added approximately $0.19 to EPS.

Despite the uncertainty attached to structured finance, Moody's management is sticking with full-year forecasts of percentage revenue growth in the mid-teens and EPS growth in the low to mid-teens.  That positive outlook reflects the continuing growth in Moody's international business, as well as strength in Moody's corporate finance ratings business.

Another good sign for Moody's is that Berkshire Hathaway (Warren Buffett's holding company) has established a huge position in the stock – 48 million shares, representing 18% of the company.  Buffett has proved time and time again that he can manage reputation risk.  Examples include his large investments in American Express after the salad oil scandal and his ownership of  Salomon Brothers during the Treasury bond scandal.  Both proved hugely profitable.

It should be noted that we do expect the company to weather a lot more bad press over the coming months. But this is a name you should watch and given the long-term quality of this business and the value in the stock, we would buy at current prices and on any dips in the next few months.
Even if Moody's results are only average for the next several years, we think long-term investors will be rewarded buying the stock at 40% less than it was a year ago!

Buy Moody's (NYSE:MCO)up to $50