Big tech and artificial intelligence (AI) stocks like Nvidia(NASDAQ: NVDA) get plenty of investor attention these days. But there are roughly 5,690 stocks listed on the Nasdaq Composite and New York Stock Exchange. Too often, investors can get caught up in buying what's popular and forget that there are lots of opportunities in the stock market.
That seems to be the case with the growth stock being featured here. It has been on an incredible run and boasts some of the best margins in the stock market. And this exceptional growth stock has a price-to-earnings ratio more than 60% higher than Nvidia's.
Determining how much of a credit risk you are
Have you taken out a loan or applied for any type of credit lately -- or ever? If so, you've probably heard of Fair Isaac's (NYSE: FICO) signature product. In 1989, it developed the FICO score, a three-digit number calculated largely based on a person's credit history. Nearly all U.S. banks and other lenders in the U.S. use versions of the FICO score to help determine if they should lend loan applicants money, whether via a mortgage, car loan, credit card, or personal loan. FICO scores above 670 are considered good, while those above 740 are very good, and anything above 800 is exceptional.
Lenders and other businesses purchase access to people's FICO scores through national credit agencies, which pay fees to FICO. Consumers can also purchase the right to see them directly from FICO and other direct-to-consumer channels. Over the last nine months, Fair Isaac's scores business generated nearly $594 million in operating income at a mind-boggling 89% operating margin -- for every $1 of revenue it takes in, Fair Isaac earns 89 cents in profit. Nvidia has recently reported operating margins of over 60%.
Analysts at Wells Fargo estimate that Fair Isaac may raise the price it charges for mortgage credit scores from $3.50 to $5 in 2025, and increase other fees as well. The result of those hikes could increase its revenue by $200 million, or 11%, next year. And the analysts predict a further hike in mortgage credit scores to $6.50 in 2026.
FICO isn't just a credit scores business, though. It has built a compelling software-as-a-service (SaaS) business that leverages data, machine learning, and artificial intelligence to help companies with a host of solutions from customer engagement, pricing, and fraud protection, as well as other business-oriented services like supply chain optimization. The SaaS business has clients in more than 100 countries, and most are signed up for multiyear subscriptions. The software segment's operating margins aren't as high as the scores business, but still were a respectable at 32% over the last nine months.
Part of Fair Isaac's strategy is to increase engagement with clients by moving all of its software solutions onto a single platform, allowing it to use a "land and expand" strategy, so sales efforts and the cost to acquire clients generate revenue more efficiently, leading to higher operating margins. Fair Isaac's excellent results have generated incredible returns -- 78% this year and 568% over the last five years -- and that has led to increased investor interest, which in turn has pushed its price-to-earnings ratio 63% higher than Nvidia's.
NVDA PE Ratio data by YCharts.
Does it make sense to buy a stock with a 106 P/E ratio?
I don't particularly like buying stocks when they are trading at such an expensive premium because it makes the company's margin for error that much slimmer. A misstep in earnings or a shift in the macro environment can send shares into free fall.
However, Fair Isaac has a rare combination of attributes. It has built a legacy business with a strong moat over the past 30 years, but it also has a newer SaaS and AI business that can benefit from the AI boom. By charging higher fees for its FICO scores, it could reap a windfall of additional revenue that could make its way to the bottom line and lower the elevated P/E in time.
I don't see an issue with investors starting a position in Fair Isaac, even while the stock is trading at these elevated valuations. The company is going to grow significantly, and this is not a "show me" story -- it is one of the best-performing companies in the S&P 500 from an operating perspective. I would be more interested in taking advantage of broader market pullbacks to buy shares of Fair Isaac, but those are, of course, hard to time.
Don’t miss this second chance at a potentially lucrative opportunity
Ever feel like you missed the boat in buying the most successful stocks? Then you’ll want to hear this.
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*Stock Advisor returns as of October 21, 2024
Wells Fargo is an advertising partner of The Ascent, a Motley Fool company. Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Nvidia. The Motley Fool recommends Fair Isaac and Nasdaq. The Motley Fool has a disclosure policy.
