Introduction
It’s time to talk about one of the dividend stock stocks on my 28-stock watch list.
On that watch list, I’m holding most of the companies I discuss on Seeking Alpha for potential inclusion in my dividend growth portfolio, which currently holds 21 individual stocks.
One of my favorites on that list is the Moody’s Corporation (NYSE:MCO), a stock I haven’t covered since February 20, when I went with the somewhat boring title “Moody’s Poised To Benefit From A Diversified Business Model.”
Since then, shares have returned 10%, beating the S&P 500 by roughly 260 basis points.
Over the past ten years, MCO shares have returned 416%, 189 points above the market’s performance.
In this article, I’ll revisit the bull case and explain why I consider MCO to be one of the best financial stocks in the market and a terrific dividend growth investment for anyone not dependent on elevated income from their investments.
So, as we have a lot to discuss, let’s get to it!
A Superior Business Model
As I have written in many articles, I try to keep a very concentrated portfolio.
Currently, I own 21 stocks. If I were to buy every stock I like, I would easily own more than 50 stocks.
The reason I’m keeping it concentrated is my belief that this adds more emphasis to my picks. If I were to buy 50 different companies, the exposure per company would be low.
While every dollar counts in long-term investing, I’m not looking to maintain small positions but put emphasis on my highest-conviction investments.
That’s also why it takes so long for me to add new positions to my portfolio, as a starter position requires a lot of cash due to my portfolio’s strong performance in recent years.
So far this year, I have added a few new stocks, including Antero Midstream (AM), Texas Pacific Land (TPL), and Old Dominion Freight Line (ODFL), which is my latest addition.
I love companies with unique business models, wide moats, and critical operations in major supply chains.
Moody’s is such a company, as it has built a business model that is close to impossible to copy, thanks to its reputation and elaborate use of advanced financial models.
In general, I have to say that each time I’m researching MCO, my heart starts to beat a little faster.
The company, whose stock price has returned 13.9% annually since 2004, is one of the world’s biggest rating agencies with a wide selection of other services built around it.
Managing two segments, Analytics and Investor Services, the company has become one of the largest global providers of ratings, research, data, and software solutions.
Even better, these operations are highly efficient, as the company has an adjusted operating margin in the mid-40% range.
Moreover, $0.67 of every $1.00 in revenue comes from recurring services, which tremendously support long-term visibility and reduce revenue/earnings volatility.
With this in mind, the company has become a cornerstone of global finance, as its products and services are critical to every actor in the global capital markets.
This reliance on its products creates a powerful network effect, which is one of the hardest competitive advantages to disrupt.
On top of that, the company has a data advantage, which provides a good foundation for new technologies, including generative AI (“GenAI”) in areas such as credit, KYC, and climate analytics.
This includes the planned release of QUIQMemo and QUICAlert.
I recently wrote an article on finance companies that benefit from the surge in AI. I believe Moody’s is one of them, as it continues to prove the effectiveness of its business model.
Moody’s Analytics has grown its revenue for 65 consecutive quarters, with six consecutive quarters of double-digit annual recurring revenue (“ARR”) growth.
Even better, the retention rate has remained steady at 94% over the past two years.
During this period, revenues in this segment have risen by 12% annually – most of it organically!
Even better, margins have risen by more than 400 basis points since 2018, with recurring revenue growing to 94%.
Since 1Q18, recurring revenue has grown by 16% annually.
Similar results are visible in the Investor Services segment, which has global coverage in cross-border and domestic debt markets.
This segment has rated more than 33,200 organizations and deals, with more than $42 trillion in rated debt in the Americas alone.
Supported by more than 1,700 analysts, this segment has built a model of more than 190 rating methodologies that creates 39% recurring revenue, which is a lot for a rating business.
Personally, I often incorporate ratings in my research when I mention a company’s credit rating. This is also based on my strategy to avoid companies with sub-BBB- credit ratings. Everything below that is non-investment grade.
In the case of Moody’s, a BBB- rating is equivalent to Baa3.
A rating has many benefits, including;
- Better access to capital as a rating can make debt potentially more attractive (some funds only invest in rated debt).
- It shows that a debt issuer is transparent.
- The good reputation of Moody’s helps to gain trust.
Looking at the numbers below, we see that debt rated by Moody’s often sells at a lower spread, reducing interest payments for the issuing company.
This segment benefits from rate cut expectations later this year (making it more likely that companies refinance), generally elevated refinancing requirements ($4.4 trillion through 2027!), and significant dry powder of private equity companies.
Headwinds are elevated funding costs pressuring weaker issuers, geopolitical issues, and recessionary risks.
However, bear in mind that as strong as Moody’s may be, recessions tend to have a major impact on its stock, as the financial sector is highly cyclical.
As we can see below, over the past ten years, 25-30% sell-offs have not been uncommon.
That said, putting both segments together, the company has a very favorable outlook, as it expects at least 10% annual revenue growth with outperforming growth in Analytics, operating margins in the low-50% range, and low-double-digit annual EPS growth.
In the first quarter, the company achieved 21% revenue growth, which was driven by a favorable issuance environment and sustained demand for the company’s risk assessment solutions.
This translated into an adjusted diluted EPS of $3.37 (+13%).
Notably, Moody’s Investors Service segment reported a 35% year-over-year revenue increase, which marked its second-highest quarterly revenue ever!
This bodes well for shareholders.
Shareholder Returns & Valuation
The good news is the company’s commitment to its dividend. Since 2001, the dividend has been hiked by 17% annually. It did not cut the dividend during the Great Financial Crisis and has consistently enjoyed a net leverage ratio below its BBB+ rating threshold.
After hiking its dividend by 10.4% on February 15, it currently yields 0.8%.
This dividend comes with a 31% payout ratio, a five-year CAGR of 11.5%, and 14 consecutive annual hikes.
While this is not a great yield, the main driver of the low yield is the company’s fantastic stock price performance, as capital gains have kept up with dividend growth, which has consistently provided a subdued yield for new investors.
So, while MCO may be wrong for income-focused investors, I’m not shying away from its subdued yield, as its yield is the only poor grade on an otherwise phenomenal dividend scorecard.
Given the company’s favorable long-term outlook, the likelihood of long-term annual dividend growth between 10-12% is very high.
Speaking of longer-term expectations, analysts agree with its outlook, as they expect Moody’s to boost EPS growth from 9% in 2024 to 15% and 14% in 2025 and 2026, respectively – using the FactSet data in the chart below.
The problem is that investors have been eager when it comes to pricing in high growth.
MCO shares currently trade at a blended P/E ratio of 39.3x, which is a mile above the long-term normalized P/E ratio of 23.1x.
Over the past five years, the normalized P/E ratio was 30.
When applying the five-year average, we get a fair price target of $424, which is 5% above the current price.
The current consensus price target is $410.
Given everything discussed in this article, I stick with a Buy rating.
The company’s business model is too strong for me to go with a Hold rating here. I would have gone with a hold if MCO were trading north of $420.
However, in this case, a 5-10% correction would make for a good entry point – unless the economy were to see a major deterioration in the months ahead. In that case, stocks could easily fall 20-30%.
Given that I own just one financial sector stock, I’m closely watching MCO, as it would make a lot of sense in my portfolio.
If I can get the stock at $150, I’ll likely make a move – despite MCO not being anywhere close to being “deep value.” At that price, I like the risk/reward a lot.
That said, I get it that some people will disagree with me.
In general, I have made the case that value stocks are likely a better place to be than growth stocks. I still stand behind that. I also get that a sub-1% yield is not enough for most.
However, as I have a multi-decade horizon (God willing), I always want to include some wide-moat growth in my portfolio.
Takeaway
Moody’s stands out as a top-tier choice on my dividend stock watch list due to its fascinating wide-moat business model and impressive financial performance.
With a track record of 416% returns over the past decade, it has consistently outperformed the market.
The company excels in its Analytics and Investor Services segments, reporting consistently high margins and significant recurring revenue while benefiting from attractive growth opportunities.
Moreover, despite its valuation, MCO’s long-term outlook remains very promising.
For those seeking quality dividend growth stocks with strong fundamentals and a wide moat, Moody’s is a compelling buy, especially on market corrections.
Pros & Cons
Pros:
- Strong Business Model: With operations in Analytics and Investor Services, MCO benefits from high margins, recurring revenues, a great reputation, and room for innovation.
- Reliable Dividend Growth: The company has hiked its dividend for 14 consecutive years, with a five-year CAGR of 11.5%. Given its growth outlook, elevated dividend growth seems to be sustainable.
- Market Leadership/Wide Moat: As one of the largest global rating agencies, Moody’s has a major role in global finance and a business model that is close to impossible to replicate.
- Growth Potential: Analysts predict double-digit EPS growth in the coming years, supported by innovative technologies like generative AI.
Cons:
- High Valuation: Trading at a P/E ratio of 39.3x, MCO is trading significantly above its long-term average, making it somewhat pricey for new investors.
- Low Dividend Yield: At 0.8%, the yield may not satisfy income-focused investors.
- Cyclical Risks: The financial sector’s cyclicality means MCO could face significant downturns during recessions.
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