Moody's

A Capital-Light Compounder

In 2000, Berkshire Hathaway spent $499 million to acquire 48 million split-adjusted shares of Moody’s ($10.40 per share). They sold a big chunk of shares in 2009-2010 (probably around $25 per share) and trimmed some more in 2013 (around $70). Aside from these moves, there has been no activity. To date Berkshire has collected about $550 million in dividends, and with the stock trading around $300 at the time of writing, the remaining 24.7 million share position is worth about $7.3 billion.

Obviously, this has been an enormously successful investment for Berkshire, albeit the initial investment was relatively small. I have estimated the IRR to be 16% and the MOIC to be a little over 17, creating over $8 billion of wealth for Berkshire over 22 years. However, one could point out that the 2009-2010 sales were a big mistake. Had Berkshire held the full position until today, the IRR would be 18%, the MOIC over 30, and the overall gain about $14.7 billion. Of course, this ignores the gains that Berkshire generated from the reinvested funds - in the 2009 shareholder letter, Buffett writes that the Moody’s sales were used to partially fund their Dow Chemical and Swiss Re purchases - investments for which I have not examined.

So what does Berkshire like about Moody’s? Moody’s is a credit ratings agency that is essentially half of a duopoly alongside Standard and Poor’s (S&P). Creditors assign great importance to their ratings - without one of their ratings, companies looking to raise large amounts of debt would have great difficulty or would have to settle for a higher cost of capital. Because of this, the ratings agencies have great pricing power: Buffett has said “we need their rating… and we are not in a position to negotiate on price.” Moody’s is also extremely capital-light. They don’t need to invest great sums into property or working capital in order to grow - all they have to do is raise prices and/or increase headcount to meet demand. In fact, Moody’s runs with a negative tangible equity balance, meaning they essentially have an infinite return on equity and can distribute 100% (or >100% of earnings as they lever up) and still grow - similar to Apple and Visa today.

In 2000, Moody’s had pre-tax income of $284 million and had 343 million split-adjusted shares outstanding at year end. In 2021, they had pre-tax income of $2.76 billion, a CAGR of 11.4%, and share count was down to 185 million (a 2.8% annualized reduction). Add on a couple percentage points for the dividend and multiple expansion and you arrive at Berkshire’s 16% IRR - another big winner, even with the ill-timed trimming.