STOCK WATCH


Moody's: Hostage to Bonds?

The credit rating company's stock is down from $71 to $56, possibly because it narrowly missed analysts' first-quarter earnings forecasts. Or is there more to the fall?



Analysts at Moody's have gored plenty of Wall Street oxen. That's their job, true, but it's still interesting to watch the Street mount a counterattack. For the heinous offense of reporting first-quarter earnings of 49 cents a share instead of the expected 50 cents, Moody's (symbol MCO) suffered as stock-market traders ripped $15 a share, or more than $4 billion, off the company's market value, since April 26. (Moody's market capitalization now stands at $16.5 billion.) That chopped the price-earnings ratio, based on Moody's past twelve months' earnings, from around 35 to 28. For an extremely profitable firm with a worldwide franchise and only one serious competitor, that sounds like severe punishment. Moody's, after all, sports a return on equity (a measure of profitability favored by many investment pros) of more than 100%. That is phenomenal.

Moody's has also been one of those rare stocks that until two weeks ago never experienced a serious setback. Since going public in 2000 at $11 (adjusted for subsequent splits), the stock has returned more than 40% in all but one of its calendar years. This performance reflects steady earnings and revenue growth of better than 20% a year.

Most of Moody's business is selling credit-rating services. U.S. customers account for two-thirds of revenues, and international customers account for the rest. Bond issuers, banks and insurance companies will always need fresh ratings to sell their securities and financial services, so a large part of Moody's business is practically guaranteed. But one reason this last earnings report wasn't a barnburner is that Moody's said its fastest-growing segment, issuing one-shot ratings for "structured finance" deals, could be slowing. These are special, apparently quite lucrative ratings that make it possible for Wall Street to repackage mortgages into securities and sell them to mutual funds and other large investors. As anyone who's refinanced a home loan knows, mortgage volume has been enormous. But with mortgage rates rising, refinancings are slowing. Moody's will feel this just enough to go from a super-high-growth business to merely a good growth business. And these days, that's a kiss of death, as far as Wall Street is concerned.

So, analysts are starting to badger Moody's. Market Edge, an independent research provider, lowered its opinion from "buy" to "hold," largely, it says, because the momentum that had pushed the stock ahead for years has peaked. Prudential Financial contends that the stock was overly punished and should be in the high $60s but isn't worth $70 or more based on current earnings expectations. That would still make it worth a shot before the eventual and inevitable bottom-fishers and value buyers elbow their way in. Still, the crux of the negative assessment focuses on current mortgage market conditions, not Moody's business strategy.

This tale shows that the stock market can be maddeningly unforgiving. Remember this next time you consider buying a stock because "it never goes down." Every stock goes down at some point.

--Jeffrey Kosnett




You can get valuable updates like Stock Watch from Kiplinger sent directly to your e-mail. Simply enter your e-mail address and click "sign up."

More Sponsored Links


Advertisement

Market Update

Advertisement

Featured Videos From Kiplinger