We came across a bullish thesis on Fair Isaac Corporation (FICO) on Substack by Ryan Reeves. In this article, we will summarize the bulls’ thesis on FICO. Fair Isaac Corporation (FICO)’s share was trading at $2088.22 as of May 9th. FICO’s trailing and forward P/E were 89.93 and 72.46 respectively according to Yahoo Finance.
A senior banker signing a loan document, emphasizing the company’s ability to finance mortgages.
FICO, founded in 1956, is a data science company renowned for its role in helping lenders assess risk, primarily through its proprietary FICO score. The company has built a business that serves over 100 of the largest banks globally by providing not just credit scores but also decision management software, consulting services, and platform-as-a-service offerings tailored to the needs of lenders. At the heart of its operations is the FICO score, which banks and financial institutions rely on to determine the creditworthiness of individuals applying for loans, mortgages, or credit cards. The company’s core service of credit scoring, often bundled with reports from the three major credit bureaus (Experian, Equifax, and TransUnion), continues to hold a dominant position in the market.
FICO’s moat is deeply rooted in the structure of the credit ecosystem. Banks rely heavily on FICO’s scoring system, which is embedded in their decision-making workflows. The inertia within banks, which have been using FICO scores for decades, makes it difficult for any competitor, like VantageScore (created by the credit bureaus), to displace FICO’s established position. Despite VantageScore being a viable alternative, it hasn’t been able to achieve the same level of adoption, mainly due to the risk banks perceive in switching to an unfamiliar system that would require overhauling their processes. Moreover, FICO’s position is further reinforced by the regulatory landscape: Fannie Mae and Freddie Mac, which oversee a significant portion of the U.S. mortgage market, require FICO scores for the sale of loans in the secondary market. With over 70% of mortgages being sold, this requirement makes FICO’s scores indispensable, securing its place as a critical player in the mortgage origination process.
The company’s unique position also affords it substantial pricing power, a key driver of its profitability. While FICO scores used to cost banks around 50 cents per credit report, the pricing has increased significantly in recent years, reflecting FICO’s ability to flex its pricing power. For instance, the cost of a mortgage origination credit report has risen by more than 10 times since 2018, from about 50 cents to upwards of $5. This price hike, coupled with the volume of transactions, has led to remarkable margins, particularly in its “Scores” segment, which boasts operating margins of around 88%. The high margins reflect the low cost of goods sold—mostly just data—and the company’s significant leverage over the credit bureaus with whom it collaborates. Even with the rising prices, FICO’s fees remain a relatively small fraction of the overall costs of a mortgage, making it a low burden for consumers while generating considerable revenue for the company.
The FICO business is not without risks, however. A potential shift in the regulatory environment could disrupt the company’s dominance. For example, the GSEs’ move to allow VantageScore as an alternative for mortgage originations could challenge FICO’s long-held control. But even as VantageScore slowly gains traction, the inertia of the lending industry favors FICO, as lenders are unlikely to switch systems unless absolutely necessary. Additionally, FICO’s growth is tied to the broader economy—more loans mean more credit checks. As economic activity rises, so does the demand for credit scores. However, in a slowing economy, the need for credit assessments diminishes, which could limit FICO’s revenue growth.
Despite these potential headwinds, FICO’s robust business model, dominant market position, and exceptional pricing power make it a compelling investment. The company’s ability to extract higher prices from its services has dramatically improved its profitability, with EBIT margins soaring from 19% in 2018 to 43% today. The company’s pricing power and relatively low capital requirements for expansion have contributed to its exceptional returns on invested capital, making it a highly attractive investment despite its premium valuation. Moving forward, FICO’s prospects remain closely tied to the continuation of its pricing power and the ability to fend off competitive threats, particularly from regulatory changes and competitors like VantageScore. The company’s dominant position and pricing flexibility ensure that it remains a powerful force in the credit assessment industry, with strong growth potential even in the face of economic volatility.
Fair Isaac Corporation (FICO) is not on our list of the 30 Most Popular Stocks Among Hedge Funds. As per our database, 60 hedge fund portfolios held FICO at the end of the fourth quarter which was 47 in the previous quarter. While we acknowledge the risk and potential of FICO as an investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns, and doing so within a shorter timeframe. If you are looking for an AI stock that is more promising than FICO but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
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Disclosure: None. This article was originally published at Insider Monkey.
