1 Financial action under the radar Warren Buffett likes

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Warren Buffett is well known for his love of bank stocks, but one of his biggest holdings in the financial industry is a company investors may not be so familiar with. In this Motley fool live Video clip, registered on August 30, Fool.com contributors Matt Frankel, CFP and Jason Hall discuss what the company is, what it does and why it plays such an important role in Berkshire Hathaway‘s (NYSE: BRK.A) (NYSE: BRK.B) equity portfolio.

Matt Frankel: You’ll talk about this one first – and I want to jump in on that as well – is in a bad mood‘s (NYSE: MCO), MCO.

Jason Hall: Yes. What I wanted to do with Moody’s is just because I think it’s so interesting. We talked about S&P Global recently, and there are basically three companies that are pretty much the same as rating companies for pretty much anything public, be it corporate debt, corporate credit ratings, etc. ‘business, all of these things that they do that put them in a position of just immense power that does that.

I will show this table. Seventy-four percent gross margins, and if you notice here you can see that the margins are actually trending up. Although you chart five years, you see the margins increase. Operating margins, upward trend. Cash flow, I really wanted to show that, we were talking about a huge cash cow business.

The first graph I showed is the global financial crisis. It’s the real estate bubble, the debt bubble, all that, and it drove the company’s operating margins, cash margins for a while. But again, the idea here, we thought these companies were going to have big problems and the federal government was going to regulate all of that, and the business model was potentially a major threat. But as we’ve seen, cash flow and margins have continued to flow very well.

Where I think Moody’s is really well positioned right now, that’s for sure, it’s still very important for ratings, it’s still their core business, but it’s an analytical business now.

Frankel: Yes. I mean, the core business by far is the scoring business, I think that’s what really attracted Buffett. They don’t own the business, but there are three main players. There are S&P [Global] (NYSE: SPGI), there’s Moody’s, and there’s Fitch Ratings. I bet you can’t tell me who # 4 is. I do not know who it is.

Room: It is not worth knowing.

Frankel: No, you don’t need to know. But then they have their analytical tools. It’s a very similar business to S&P Global, if you saw our show a few weeks ago where we talked about it. They are one of the best players in a market that has only a few players. I think that’s really what attracted Buffett here. It is a company in the financial sector. He reduced a lot of his holdings in the financial sector. I don’t really see his Moody’s stake going anywhere. They currently own just over 13% of the business, and I think it’s going to stay that way.

Room: I think it’s going to increase because, again, this is the ideal Buffett company in so many ways. He’s been paying a dividend, he’s been increasing that dividend every year, for a dozen years now. Because of its scale and size, they’re going to start buying back stocks over time, so you’re going to see so many of those other Buffett stocks. While Buffett may never buy another stock, his position will grow because the company repurchases and reduces the count of those shares. These are the things that make him very Buffett.

I think it’s too easy to take on. There are three of these companies, they each have their own market share, and that doesn’t really change significantly from year to year. It seems like it’s not just “Why own it?” But at the end of the day, the company will see medium to low single-digit revenue growth. But because of its business model, the extra margins and extra cash margins from that revenue is the reason you saw on the chart that its margins and operating results continue to grow at an inordinate rate. It can increase profits and cash flow at a double digit rate every year just because those new sales are worth more money.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.


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