Which Financial Stock Holds the Earnings Edge - First American Financial (FAF) or Moody's Corporation (MCO)?

The financial services sector is poised to undergo significant expansion due to substantive demand among enterprises and the rising integration of cutting-edge technology. Banks, insurance firms, brokerage entities, and money management institutions could further benefit from the high-interest rate environment.

This article evaluates and compares the fundamentals of financial services companies, Moody's Corporation (MCO) and First American Financial Corporation (FAF), to ascertain which one is better equipped to capitalize on the flourishing industry momentum as these stocks prepare for their quarterly earnings releases.

Historically, the financial services sector has often been a catalyst for progression, helping individuals and organizations navigate socioeconomic shifts. Service providers within the financial services industry, such as insurance, investment management, banking, and capital markets, are well-positioned to remain resilient and experience considerable long-term growth, fueled by escalating demand for financial services from enterprises.

The interest rates, currently set between 5.25%-5.5%, are anticipated to remain elevated for some more months before projected rate cuts commence. The revenue of the financial services industry positively correlates with higher interest rates. High-interest conditions compel borrowers to pay more interest, thereby creating a potential avenue for increased revenue for these service entities.

Furthermore, the continued digitalization of financial services like credit card processing, easy credit, insurance coverage, tax accounting methodologies, wealth management, mortgage financing, and 'Buy Now Pay Later' (BNPL) solutions have induced a paradigm shift within the finance sector.

From a technological perspective, financial companies anticipate leveraging cutting-edge GenAI technology for improved fraud detection and insightful behavioral analysis of customers. This development can, in turn, bolster sector growth even further.

The financial services market is expected to grow from $31.14 trillion in 2023 to $33.54 trillion in 2024 at a CAGR of 7.7%. The market is expected to witness stronger growth, reaching $44.93 trillion in 2028, growing at a CAGR of 7.6%.

With a market cap of over $73 billion, MCO operates as an integrated risk assessment firm worldwide. Meanwhile, FAF, with a market cap of $6.25 billion, is a premier provider of title, settlement, and risk solutions for real estate transactions and the leader in the digital transformation of its industry.

The fourth-quarter results for both MCO and FAF are due for revelation soon. MCO’s revenue and EPS are expected to increase 15.3% and 44.9% year-over-year to $1.49 billion and $2.32, in the fiscal fourth quarter ending December 2023, while FAF's revenue and EPS are expected to decline 10% and 39% year-over-year to $1.52 billion and $0.82, respectively.

In terms of price performance, MCO has gained 30.7% over the past nine months, while FAF gained 5.9%. However, over the past year, MCO has gained 21.3% to close the last trading session at $399.60, whereas FAF has lost 5% to close the last trading session at $60.57. MCO is a clear winner here.

Here are the reasons why I think MCO might perform better in the near term:

Recent Financial Results

MCO’s revenue for the fiscal third quarter that ended September 30, 2023, came at $1.47 billion, up 15.5% year-over-year, while its adjusted operating income grew 32.2% from the prior-year quarter to $657 million.

The company’s adjusted net income and adjusted EPS rose 31.5% and 31.4% from the prior-year quarter to $447 million and $2.43, respectively. For the nine months that ended September 30, 2023, its free cash flow increased 65.3% year-over-year to $1.48 billion.

On the contrary, FAF’s net sales came to $1.48 billion during the fiscal third quarter ended September 30, 2023, reflecting a decline of 18.8% year-over-year. Adjusted net income and adjusted net income per share stood at $128.20 million and $1.22, down 27.5% and 27.4%, respectively, from the year-ago quarter.

However, FAF’s cash and cash equivalents, as of September 30, 2023, stood at $1.58 billion, compared to $1.22 billion as of December 31, 2022.

Past And Expected Financial Performance

MCO’s revenue has grown at 4.7% CAGRs over the past five years, while FAF’s revenue has grown at 1.5% CAGRs over the same period. MCO’s EBITDA and EBIT grew at 2.6% and 1.3% CAGRs, respectively, over the past five years, while FAF’s EBITDA and EBIT grew at negative 5.8% and 9.5% CAGRs, respectively.

Analysts expect MCO’s revenue to increase 9% year-over-year to $1.60 billion in the fiscal first quarter ending March 2024, while EPS is expected to come at $2.82. The company surpassed consensus revenue and EPS estimates in each of the trailing four quarters, which is impressive.

FAF’s revenue is expected to decline 1.2% year-over-year to $1.43 billion, while EPS is expected to rise 47.2% year-over-year to $0.72 in the fiscal first quarter ending March 2024. The company surpassed consensus EPS estimates in three of the trailing four quarters while failing to surpass consensus revenue estimates in three of the trailing four quarters.

Profitability

MCO’s trailing-12-month EBITDA margin of 42.80% is higher than FAF’s 9.66%. In addition, MCO’s trailing-12-month Return on Total Capital of 12.11% is higher than FAF’s 3.91%. Moreover, MCO’s trailing-12-month Return on Total Assets of 11.87% is higher than FAF’s 2.22%.

Thus, MCO seems more profitable.

POWR Ratings

MCO has an overall rating of B, which equates to a Buy in our proprietary POWR Ratings system. Conversely, FAF has an overall rating of C, translating to a Neutral. The POWR Ratings are calculated considering 118 different factors, with each factor weighted to an optimal degree.

Our proprietary rating system also evaluates each stock based on eight distinct categories. MCO’s Quality grade of B is in sync with its higher-than-industry profitability metrics. Its trailing-12-months EBIT margin of 36.43% is 71.9% higher than the industry average of 21.20%. Moreover, its trailing-12-month CAPEX/Sales of 4.84% is 138.8% higher than the industry average of 2.03.

Conversely, FAF’s C grade for Quality justifies its mixed profitability. Its trailing-12-month EBIT margin of 6.76% is 68.1% lower than the industry average of 21.20%. However, its trailing-12-month CAPEX/Sales of 4.41% is 117.7% higher than the industry average of 2.03.

Within the Financial Services (Enterprise) industry, MCO is ranked #12 out of 100 stocks, while FAF is ranked #41.

Beyond what we’ve stated above, we have also rated both stocks for Growth, Value, Momentum, Stability, and Sentiment. Click here to view MCO ratings. Get all FAF ratings here.

The Winner

As we delve deeper into the digital age, observing a marked surge in advanced technologies, the financial services industry finds itself on the cusp of unprecedented growth and expansion. High interest rates are set to further bolster this performance, potentially boosting profitability for those within the sector. Industry players MCO and FAF could benefit from these industry tailwinds.

However, it is MCO stands out notably due to its profitability, promising outlook, vigorous financial health, and encouraging bottom-line forecasts, making it the more advantageous pick now.

Our research shows that the odds of success increase when one invests in stocks with an Overall Rating of Strong Buy or Buy. View all the top-rated stocks in the Financial Services (Enterprise) here.

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MCO shares closed at $399.60 on Friday, down $-2.94 (-0.73%). Year-to-date, MCO has gained 2.31%, versus a 4.01% rise in the benchmark S&P 500 index during the same period.

The stock market dynamics sparked Sristi's interest during her school days, which led her to become a financial journalist. Investing in undervalued stocks with solid long-term growth prospects is her preferred strategy. Having earned a master's degree in Accounting and Finance, Sristi hopes to deepen her investment research experience and better guide investors.

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