Years ago, the rating agencies were just the types of business that value investors loved to own. After all, these are businesses with dominant franchises, recurring revenue streams and a monopolistic operating environment.
IN PICTURES: Eight Ways To Survive A Market Downturn

The Big (and Only) Three
In fact, virtually all ratable credit instruments are rated by either Moody's (NYSE:MCO), Standard and Poor's, which is part of McGraw Hill (NYSE:MHP), and Fitch Ratings, which is majority-owned by the French company Fimalac.

Considering that no bond can be priced and sold unless it's rated by a major rating agency, it's not surprising that Warren Buffett's Berkshire Hathaway (NYSE: BRK-A)(NYSE:BRK-B) invested into Moody's many years ago. Buffett continues to hold Moody's, but has recently been selling off Berkshire's stake. Investors should remember that Buffett bought into Moody's many years ago and has a cost basis that still leaves him with a profitable holding. At the same time, over the years the rating agencies have relied more and more on the ratings business, versus the other lines of business like publishing, to fuel earnings growth. (For related reading, check out What Is A Corporate Credit Rating?)

A New World
In a normal world, the rating agencies would still be considered incredible cash-generating machines. Unfortunately, many experts argue that one of the root causes of the financial credit catastrophe last year was a result of egregious rating standards on behalf of the rating agencies. And it seems like the rating business is due for some heavy doses of regulation.

To be fair, rating agencies argue that they are not experts, but merely work to provide a service, and their ratings are mere opinions which should be protected by the right to free speech. (For more, check out The Debt Ratings Debate.)

Whether or not the above holds true, the SEC is taking a very hard look at imposing extremely stiff regulations and higher standards of accountability for the rating agencies. Evidence is even starting to appear that despite the fact that the rating agencies were expressing opinions, many employees were more than aware that they were giving investment grade ratings to some awful stuff.

Shorting the Ratings Agencies
In fact, such behavior has hedge fund manager David Einhorn short both Moody's and McGraw Hill. Einhorn runs Greenlight Capital and is Chairman of Greenlight Capital Reinsurance (Nasdaq: GLRE). Last year, Einhorn was vocal about Lehman Brothers and why it was insolvent months before the bank actually went under. Needless to say, his going short Lehman paid off tremendously.

Bottom Line
Regardless of what happens, it is a near certainty that the rating agencies will ultimately be under some sort of very onerous regulatory standards; the consequences of the credit crisis were too severe. So, despite any temptation to own a piece of these dominant franchises, investors would be well advised to ignore them for the time being. (For further reading, see A Brief History Of Credit Agencies.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  2. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  3. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  4. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  6. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  7. Professionals

    What to do During a Market Correction

    The market has what? Here's what you should consider rather than panicking.
  8. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
  9. Mutual Funds & ETFs

    ETF Analysis: Schwab US Broad Market

    Take an in-depth look at the Schwab U.S. Broad Market ETF, an incredibly low-cost fund based on a wide selection of the U.S. equity market.
  10. Professionals

    Tips for Helping Clients Though Market Corrections

    When the stock market sees a steep drop, clients are bound to get anxious. Here are some tips for talking them off the ledge.
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hunting Elephants

    The practice of targeting large companies or customers.
  3. Warren Buffett

    Known as "the Oracle of Omaha", Buffett is Chairman of Berkshire ...
  4. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  5. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  6. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  4. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  5. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
  6. What happens to the shares of stock purchased in a tender offer?

    The shares of stock purchased in a tender offer become the property of the purchaser. From that point forward, the purchaser, ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!