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(B)(N) MCO Moody’s Corporation

December 17, 2012

Drama. The bond and credit rating authorities, Moody’s Investors Services and Standard & Poor’s Rating Services, have raised some flags regarding the prospects of the Canadian Banks next year (The Canadian Press, December 14, 2012, S&P downgrades rating for 6 Canadian Banks and CBC News, October 26, 2012, Moody’s reviews 6 Canadian banks for downgrade). However, the “investment problem” whether it be corporate or government bonds, or equities, is always the same. Can we expect to get our money back with a hopeful return that exceeds the rate of inflation? Please see the Posts, The Price of Risk, August 2012, or more colourfully, The Shire Green, December 2012, which briefly reviews the Nobel Foundation’s one hundred years of  “safe investing” experience.

Companies, of course, pay for these ratings and they’re not cheap starting at about $25,000 for each instance, bond or preferred share, to find out whether they are “investment grade” or not, particularly for pension, trust and endowment fund holdings. For example, the Moody’s rating scale for “investment grade” is any of Aaa/Aa1/Aa2/Aa3/A1/A2/A3/Baa1/Baa2/Baa3 (Source: Moody’s Investors Service) and each lower grade tends to encourage investors to demand a higher rate of interest in some tens of basis points and there are many fiduciaries who cannot invest in anything that is not deemed “investment grade” by one of these authorities who tend to reach similar conclusions from similar assumptions and observations and prognostications.

But that doesn’t answer the investor question – is our money safe, can we expect to get it back with a hopeful return above the rate of inflation – not to mention, of course, the many corporate bond defaults, government defaults in foreign locales and the many banks, mortgage companies and insurance companies that took their Gold Star Ratings over the financial cliff of 2005 through 2009 (five years in a row which seems like a long time not to know anything).

Nevertheless, the Moody’s Corporation and the Standard & Poor’s Rating Service (which is a division of MHP McGraw-Hill Companies) are, in our opinion, both “investment grade” (please see Exhibit 1 and 2 below) and entitled to be in the Perpetual Bond™ at the present time, with the usual caveats regarding “controllable risk” (please see almost any of these Posts or The Wall Street Put, August 2012) which the bond holder just doesn’t have – they’re either in for the duration or trying to find a customer to take or swap their holding and they have acquired, therefore, liquidity risk as well as capital risk and inflation risk. What kind of help is that?

Moody’s Corporation has a current market value of $10 billion but nearly nothing on its books. The total assets are about $3.6 billion offset by total liabilities of $3.3 billion and a net worth or shareholders equity of $300 million, up from minus ($900 million) in 2008 and minus ($169 million) last year. The company has recently raised its stock dividend to $0.80 per share or $180 million per year for a current yield of 1.7% which is at least comparable to inflation. The current stock price is $49 today and up 40% since this time last year. The Risk Price (SF) is $36 and our estimate of the downside due to volatility is minus ($4) (please see our Post, Popoviciu’s Volatility, September 2012, for more details on this calculation). Obviously, we have gains to lock in and we’re doing that now. The long protective put at $48 in February is $1.95 today and we can partially offset the cost of that by shorting (or selling) the opportunistic call at $50 for $1.90 so that for a net cost of $0.05 per share we can lock in our price at no less than $48 per share and no more than $50 per share for the next two months.

Exhibit 1: (B)(N) MCO Moody’s Corporation – Risk Price

(B)(N) MCO Moody's Corporation

Moody’s Corporation is a provider of credit ratings, credit and economic related research, data and analytical tools, risk management software and quantitative credit risk measures, credit portfolio management solutions and training services.

(Please Click on the Chart to make it larger if required.)

Similarly, McGraw-Hill Companies (the parent of Standard & Poors) at the current price of $55 is up +20% for the year and pays a stock dividend of $1.02 per share or $284 million per year for a current yield of 1.9%. We’ve owned it in the Perpetual Bond™ since $32 in 2010 (please see Exhibit 2 below, Red Line over Black Line which is the Risk Price (SF)) but apart from liquidity needs, there is no incentive for us to sell it now (whereas a volatility-based manager or a CAPM model might demand it let alone to hold it for that long).

The volatility-based downside is minus ($4) but we also notice that the current stock prices significantly exceed the price of risk, the Risk Price (SF) at $31, and that difference needs to be earned or have the reasonable promise to be earned if the stock price is to be maintained (please see our Post, The Price of Risk, August 2012, which explains why stock prices above the price of risk are an “economic free good”). A stop/loss at $51 ($55 less $4) doesn’t really hurt us but we can do better by locking in our prices against an unexpected downside which is often the response to a large unexpected upside (please see our Posts, The Wall Street Put, August 2012 and Momentum, December 2012). For example, the February put at $55 costs $1.55 per share today and the short (or sold) call at $60 sells for $0.60 so that for $0.95 per share ($1.55 less $0.60) we can lock in our prices at no less than $55 and no more than $60 until mid-February when more information might be available to us.

Exhibit 2: (B)(N) MHP McGraw-Hill Companies – Risk Price

(B)(N) MHP McGraw-Hill Companies

McGraw-Hill Companies Incorporated is a global information services provider serving the education, financial services and business information markets with a range of information products and services.

(Please Click on the Chart to make it larger if required.)

The dark Red Line, Stock Price (SP), is the stock price at which we are buying, holding or selling the stock (absent the “collar” or stop/loss, if any) and the dark Black Line is the Risk Price (SF) which is our estimate of the “price of risk” or the “least stock price at which the company is likeable” (Goetze 2009). Please see our Posts, The Price of Risk, August 2012 and The Nash Equilibrium & Its Stock Price, October 2012, for more information.

Postscript

We are The RiskWerk Company and care not a jot for mutual funds, hedge funds, “alternative investments”, the “risk/reward equation” and every other unprovable artifact of investment lore. We have just one product

The Perpetual Bond™
“Alpha-smart with 100% Capital Safety and 100% Liquidity”
Guaranteed
With No Fees and No Loads on Capital

For more information on RiskWerk, please follow the Tags or Categories attached to this Letter or simply enter Search for additional references to any term that we have used. Related data may be obtained from us for free in a machine readable format by request to RiskWerk@gmail.com.

Disclaimer

Investing in the bond and stock markets has become a highly regulated and litigious industry but despite that, there remains only one effective rule and that is caveat emptor or “buyer beware”. Nothing that we say should be construed by any person as advice or a recommendation to buy, sell, hold or avoid the common stock or bonds of any public company at any time for any purpose. That is the law and we fully support and respect that law and regulation in every jurisdiction without exception and without qualification to the best of our knowledge and ability. We can only tell you what we do and why we do it or have done it and we know nothing at all about the future or the future of stock prices of any company nor why they are what they are, now. The author retains all copyrights to his works in this blog and on this website. The Perpetual Bond®™ is a registered trademark and patented technology of The RiskWerk Company and RiskWerk Limited (“Company”) . The Canada Pension Bond®™ and The Medina Bond®™ are registered trademarks or trademarks of the Company as are the words and phrases “Alpha-smart”, “100% Capital Safety”, “100% Liquidity”, ”price of risk”, “risk price”, and the symbols “(B)”, “(N)” and N*.

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