Moody’s Corporation (MCO), Berkshire Hathaway Inc. (BRK.A): How to Recognize a Strong Economic Moat

Look at these margins!

Moody’s requires so few assets and uses enough debt financing that it consistently reports negative equity on its balance sheet, a phenomenon that frequently identifies a low-capital-expenditure, high-cash-flow business. So Moody’s Corporation (NYSE:MCO) mints money. In 2012, Moody’s raked in $690 million in net income, up from $507 million in 2010. And this income didn’t come at the expense of cash flow. In 2012 alone, the company generated $995 million, up from $185 million in 2010. That’s a whopping rise of 440% in only two years. Obviously, you can’t generate that much cash without having terrific margins. Moody’s boasts an operating margin exceeding 40% (!) and a net profit margin of over 25%. As I wrote earlier, that’s a sure sign of an economic moat. In addition, Moody’s doesn’t require an expensive plant to run its operations. It has very low capital expenditures, which explains why it can show a 20% return on its assets.

Valuation

Such a great business doesn’t come cheap, but Moody’s Corporation (NYSE:MCO) isn’t expensive either. The rating agency currently trades at a forward price-to-earnings of only 15x. If you consider the more acceptable form of valuation, the cash flow basis, Moody’s isn’t expensive either. It now trades for about 14 times free cash flow. I don’t find Moody’s Corporation (NYSE:MCO) at all overvalued these days.

The Foolish conclusion

If you wish to become a successful investor, always make sure you can spot a strong economic moat from a distance. Moody’s, with its cash flow generation, exceptionally high margins, and a strong and loyal customer base, is the perfect example of a business with a strong economic moat. Invest accordingly.

The article How to Recognize a Strong Economic Moat originally appeared on Fool.com.

Shmulik is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

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