Moody’s

The Big Three credit rating agencies in the world are Standard & Poor’s (S&P – owned by S&P Global Inc), Fitch and Moody’s. In 2013, they held global market share of ~95% with S&P and Moody’s holding approximately 40% and Fitch around 15%. What a credit rating agency does is to rate a debtor’s ability to pay back debt by making timely interest payments and the likelihood of default.

For oligopoly business structure like this, I don’t analyze the companies much, such as the strength, the weakness, the prospect, the risk, etc. They are the largest companies in the world in their specific business and they are followed by many analysts and fund managers. I will not have any special insight to beat these analysts. You should expect the price to be relatively efficient in normal times, and that normal price fluctuation (+/- 20% in a year) to occur as usual.

In oligopoly business, I go straight to historical performance and look for one thing: consistency. Specifically, I look for consistency in revenue growth, operating margin, ROE. If they can maintain their operating margin while growing the revenue and achieve high ROE at the same time, you know that they are dominant in their fields with competitive advantages. They are likely to continue maintaining the margin and return on capital unless something disrupt their business in future.

S&P Global, formerly known as McGraw-Hill Companies

I bought S&P Global Inc in January 2009 at 23.87 and sold it at 38.50 in August 2011. That’s 61% return in USD in 20 months, BUT… it’s now at 126! That’s 3.3x my selling price! Huge mistake to sell it!!! I was so silly. My period of inactivity in personal trading from late 2011 to mid 2015 cost me so much missing opportunities.

S&P Global - Share Price - 2017-02-15.PNG

Source: Google Finance

Trading US stocks

Now, US stocks are in record high. It’s very difficult to find bargain stocks. When correction happens, be prepared to suffer 10-20% loss even if you are holding wonderful companies.

S&P 500 - 2017-02-14.PNG

Source: Google Finance

The dilemma is that US stocks were already high in 2015. If you quit US market back then, you would have missed out the continued rally as US market returned more than 15% from the start of 2015 till now. So, if you quit US market now, you don’t know if you’d miss out another 10-20% rally like what happened in 2015-2016. Afterall, you didn’t expect US market to rally after Trump’s win, did you?

S&P 500 - 2015 to 2017-02-14.PNG

Source: Google Finance

I find it difficult to find bargain stocks in US now, but I do want to get some exposure to US market. So, I look for defensive companies with stable earnings even during recession. This time, I looked at Moody’s.

Moody’s

Even during 2008-2009 GFC, Moody’s was still making at least 38% operating margin. Revenue and net profit did fell during GFC, but it remained so profitable with strong free cash flow. Being a service company, its capex requirements were very small. ROA was above 20%. So, this fits my definition of defensive companies with stable earnings. It has consistency in revenue growth, operating margin and ROE.

Moody's - Financial 10Y - 2017-02-14.PNG

Moody's - Profitability 10Y - 2017-02-14.PNG

Source: Morningstar.com

 

For companies with such quality and financial stats, you don’t want to overthink or overanalyze. You just have to make sure you buy at a reasonable price and don’t sell during panic.

Expectation

Moody’s net profit was falling in 2015 and 2016. For 2017, market is expecting 5-10% growth. Note: market is usually generous in forecasting for earnings growth, and its reliability is doubtful. But that forecast at least tells you that the prospect is not fantastically bright. The P/E of 20-23x is quite high for such growth prospect. Therefore, you can’t expect getting big return from holding Moody’s unless it beats the market expectation substantially.

Over long term, US stock market generates average 8-10% annual return, including dividends. If Moody’s is priced efficiently now, you can’t expect to get much higher return than the average. You can get higher return if you buy Moody’s at undervalued price or Moody’s performance exceeds market expectation.  With that in mind, I set my expectation of investing in Moody’s to be around 8%.

In December 2016, I bought Moody’s at 99.32 and I just sold it at 108.03 last week, making 8.7% return in USD in slightly less than 2 months. After adjusting for costs and small forex loss, the net return was 7.3% in SGD.

Trading Strategy

This is actually a trading strategy that I’m going to share, not a long-term investing strategy. I don’t advise general public to practise trading strategy. I hardly use any trading strategy myself, and when I do, I usually focus on buying really good companies that I’ll be comfortable holding for 5 years or more. I also make sure I don’t buy at unreasonable valuation. In that case, if my trading strategy turns out to be wrong, at least, I can fall back to holding a good quality company at fair value.

Here’s my thought process leading to buying and selling Moody’s:

From end of 2010 to end of 2014:

Moody’s share price rose from 26 to 95, generating 265% return before dividends. The strong return came from both rising earnings and valuation multiple. Net profit rose by 95% and the company bought back shares by close to 10%. Hence, EPS rose by 115%. Then, P/E ratio rose from 12.3x to 21.7x! It’s a great buy after the GFC, but I missed it.

Moody's - Share Price - 2009-2014.PNG

Source: Google Finance

Moody's - Valuation 10Y - 2017-02-14.PNG

Source: Morningstar.com

From end of 2014 to end of 2016:

Revenue growth slowed down and margin fell. EPS stayed relatively flat because of share buyback. The share price started at $95, rose to $112, fell to $83, rose back to $109 and fell to $95. So, it’s be trading in the range $83-110 with P/E ratio 18-23.7x. It spent only two months at the start of 2016 below $95. Those two months were like mini sell-off in several stock markets. Excluding those two months, the price was trading in the range 95-110 with P/E ratio 20.5-23.7x.

Moody's - Share Price - 2015-2016.PNG

Next, forward expectation in December 2016:

EPS for 9M16 was flat from 9M15 mainly because of share buy-back. Revenue continued to grow but the margin fell. The share price fell from the high of $109 in Sept 2016 to $99 in early Dec 2016. The P/E dropped to 21.3x, which was in the middle of the trading range over the past 2 years (or near the bottom if we exclude the mini sell-off in the first two months of 2016).

After US election, there was Trump rally, but Moody’s, in contrast, stayed relatively flat. I thought Trump rally could last a bit longer, and Moody’s would eventually follow the trend. After all, it’s in the middle (or near the bottom) of trading range. So, I bought it at 99.32 on 13 Dec. If Trump rally died off immediately after my purchase, I reckoned Moody’s wouldn’t be much impacted as it didn’t benefit from it either.

Soon after that, as usual, the share price fell to 94 by end of December. I was never good at timing. But, it started rising in 2017 to $108-109 now. As this is the top of the trading range over the past two years, I sold out at 108.03 on 9 Feb 2017. That’s 8-9% return in USD for me, meeting my investment objective in Moody’s.

Moody’s might continue rising, but I won’t be able to know. I have to stick to my trading strategy, which is buying at the low end of the trading range and selling at the high end of the trading range. Now that I get back my capital with profit, I’m looking at the next thing to invest.

 

 

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