Fair Isaac: A Long-Term Owner's View

【Fact】 At the industry level, FICO is not in a single industry. It combines "mature credit scoring infrastructure" with "growing enterprise decisioning software." Demand for scoring is stable over the long term because any modern consumer credit system needs standardized risk pricing. At the same time, the pace of replacement is slow because once a model is embedded in credit policies, capital measurement, risk thresholds, and regulatory workflows, switching costs are very high. Fiscal 2022 was a useful test: against a backdrop of sharply rising interest rates and pressure on U.S. mortgage originations, FICO's Scores segment revenue still grew 8%. In 2025 and the first half of fiscal 2026, the company again restored strong growth with higher prices, mortgage recovery, and renewal factors working together.

【Fact】 But the industry is not without disruption risk. In its 10-K, FICO lists Equifax, Experian, TransUnion, VantageScore, and other analytics model providers as competitors, and explicitly mentions that technologies such as neural networks, machine learning, and artificial intelligence systems may intensify competition. More importantly, on April 22, 2026, the FHFA announced that Fannie Mae, Freddie Mac, and FHA were advancing implementation of new mortgage credit scoring models, allowing VantageScore 4.0 and FICO 10T to enter a new competitive stage and immediately accepting Vantage-scored loans submitted by approved lenders. This does not mean "FICO has been kicked out," but it does mean "the U.S. mortgage scoring market has entered a new competitive era."

【Opinion】 Therefore, I rate industry attractiveness at 4/5: this is a good industry with stable long-term demand and high barriers to entry. But the fattest profit pool within it, U.S. mortgage scoring, is now starting to face more real institutional competition and can no longer be valued as if it will have "zero disturbance forever."

On the moat, my conclusion is this: FICO's moat mainly comes from brand standard status, switching costs, channel embedding, regulatory habit, data and model validation history, rather than a traditional low-cost manufacturing advantage. Across multiple reporting periods in 2023, 2024, and 2025, the company disclosed that one important driver of B2B Scores revenue growth was higher per-use/unit pricing, even when mortgage volume was not always a tailwind. That shows real pricing power. The Scores segment operating margin has long been around 88%, and reached 91% in fiscal Q2 2026. This is almost a textbook example of an "asset-light plus standardized franchise" model. The moat in Software is clearly weaker, but the acceleration in Platform ARR at least shows that FICO is not merely telling a story about "turning algorithmic capability into a platform."

In addition, FICO does have data network effects in software and fraud prevention use cases. In its annual report, the company discloses that its Falcon Fraud Manager / Falcon Intelligence Network connects more than 10,000 financial institutions, payment providers, and merchants. This kind of collaborative data network can improve model performance and customer stickiness. In regulated industries, FICO also continues to emphasize explainable machine learning, compliant decisioning, and model governance. These factors may instead become "slow-variable advantages" in the AI era.

Overall, I rate FICO's moat strength at 4.5/5. But it is important to be explicit: 【Inference】 The moat remains very strong overall, but it is not widening across the board. The Scores moat is broadly stable and relatively wide; the Software moat is still being built; regulatory opening in mortgage scoring has narrowed the edge of the core moat's "absolute exclusivity." Replicating this position is not just a matter of spending money. It requires years of model validation, credit bureau cooperation, embedding in lender workflows, and regulatory acceptance. But once the system begins to lean toward open competition, the difficulty of replication shifts from "almost impossible" to "extremely slow but possible."

If the stock market closed for five years tomorrow, I would be willing to own the business itself. But if today were the first purchase, I would not want to lock in the next five years of returns at this price. The former is a judgment about enterprise quality. The latter is a judgment about purchase price. The two should not be confused.

Management and Capital Allocation

【Fact】 The management governance framework is generally a positive. The 2026 proxy statement shows that CEO William Lansing owned 420,431 shares, about 1.77% of shares outstanding. The company requires the CEO to hold at least 100,000 shares, and executive vice presidents to hold shares worth at least five times their annual base salary. The company also discloses relatively shareholder-friendly governance arrangements: executives are prohibited from hedging or shorting company stock, there are no guaranteed bonuses, no repricing of underwater options, clawback provisions are in place, change-in-control provisions use double triggers, and both directors and executives are subject to stock ownership requirements. From the perspective of honesty and alignment of interests, this framework is above average overall.

【Fact】 Incentives are indeed linked to operating results. The proxy statement shows that management's core evaluation metrics include Adjusted Revenue, Adjusted EBITDA, and relative total shareholder return. Actual fiscal 2025 Adjusted EBITDA was $1.1098 billion, versus $904.1 million in fiscal 2024. The company also disclosed fiscal 2025 free cash flow of $739.4 million, compared with $607.4 million in fiscal 2024. This at least shows that the board is not focused only on revenue scale, but also on profitability and cash.

What deserves more caution is capital allocation. 【Fact】 FICO puts buybacks at the center of capital allocation, states clearly in investor materials that "repurchases are an important component of the capital allocation strategy," and has a history of "over 20 years of continuous repurchases." Recent buyback amounts were approximately: $882.2 million in 2021, $1.1 billion in 2022, $407.3 million in 2023, $833.3 million in 2024, and $1.4 billion in 2025. In the first half of fiscal 2026, the company repurchased another $773.9 million of stock. In February 2026, the board also raised the latest repurchase authorization to $1.5 billion, with $1.1 billion remaining as of March 31, 2026. Meanwhile, diluted weighted average shares fell from about 25.36 million shares in 2023 to about 24.56 million shares in 2025, and further to 23.85 million shares in the first half of fiscal 2026. These figures show that management is indeed continuously returning cash to shareholders.

【Inference】 The issue is not "whether there are buybacks," but "whether the repurchase price is rational." In fiscal 2024, the company repurchased 606,000 shares at an average price of about $1,366/share. In fiscal 2025, it repurchased 800,000 shares for a total of $1.4 billion, implying an average price of about $1,750/share. In fiscal Q2 2026, it again repurchased at an average price of about $1,251/share. Relative to the neutral intrinsic value range given later in this report, most of the 2024-2026 buybacks cannot easily be described as "outstanding capital allocation during clear undervaluation." They look more like "a capital return method supported by extremely strong cash flow and a management team with a strong preference for buybacks." This helps per-share metrics, but it is not necessarily always done at the most disciplined price.

Now look at leverage. 【Fact】 Total debt rose from $1.268 billion at the end of 2021 to $2.2 billion at the end of 2024 and $3.1 billion at the end of 2025. As of March 31, 2026, the carrying value of Senior Notes was about $3.4 billion, with another $265 million of revolving credit borrowings. The company's current leverage covenant limit is 3.5x, while the leverage metric disclosed in Q2'26 investor materials was 2.61x, so it is not dangerous in the short term. But this also means it is no longer the kind of ultra-light-asset company with "almost zero capital structure risk."

【Opinion】 Therefore, I rate management and capital allocation at 3.5/5. Operating execution, governance quality, and shareholder orientation are all good. But continued large buybacks during a high-valuation period, combined with higher leverage, prevent me from rating capital allocation as "excellent." Long-term shareholders naturally like buybacks, but long-term owners care more about whether the company is buying back its own business when it is cheap. On this point, FICO has not given me a strong enough sense of "price discipline" in recent years.

Financial Quality and Owner Earnings

Start with the hard numbers from the past five years. The table below uses company annual report/quarterly report definitions where possible, and defines free cash flow consistently as operating cash flow minus capital expenditures. Starting in 2024, capital expenditures include PPE purchases + capitalized internal-use software, to avoid overstating cash earnings power.

The table is based on the company's 2021, 2022, 2023, 2024, and 2025 annual reports, plus the fiscal 2026 second-quarter report. LTM is calculated using FY2025 plus the first half of fiscal 2026, minus the first half of fiscal 2025.

There are four important conclusions from this table. First, revenue growth has steadily accelerated: from 2021 to 2025, revenue compounded at about 10.8%, while free cash flow compounded at about 15.4%. Second, earnings quality is high: free cash flow exceeded net income in every year from 2021 to 2025, meaning profits are not empty accounting numbers. Third, capital intensity is very low: even after including capitalized internal software in capital expenditures for 2024-2025, capex as a share of revenue is still broadly only around 1%-2%. Fourth, operating leverage is extremely strong: operating margin rose from 38.3% in 2021 to 46.5% in 2025, and the LTM figure through March 2026 had already exceeded 50%. This kind of financial profile is usually only achievable by companies with extremely high business quality, very strong unit economics, and reinvestment needs that do not consume much cash.

At the same time, we should look at the "crisis test." 【Fact】 In fiscal 2022, when the mortgage market was under pressure, the company still generated $1.38 billion of revenue, $374 million of net income, and $503 million of free cash flow. This shows it is not a fragile model that looks good only when growth is fast and breaks down as soon as the environment worsens. 【Inference】 The high gross margin, high barriers, and low capex nature of the Scores business provides a very strong buffer during periods of macro pressure.

On working capital, FICO is not a company where inventory matters. The real items to watch are accounts receivable, deferred revenue, RPO, and DSO. As of March 31, 2026, short-term receivables were $620 million, up from $529 million at the end of September 2025. But investor materials also show DSO improving from 95 days to 86 days. Deferred revenue edged down from $189.2 million to $185.0 million, while RPO rose from $655.7 million to $717.7 million. This suggests the revenue structure has not obviously deteriorated. It looks more like balance sheet fluctuation from high growth than collection losing control.

The balance sheet shows a state of "operational strength, but a less conservative capital structure." As of March 31, 2026, the company had cash and investments totaling about $272.5 million, but total debt of about $3.665 billion and net debt of about $3.39 billion. Based on the leverage metric disclosed by the company, it remained at 2.61x, below the covenant limit of 3.5x. Using the LTM EBIT estimate in this report, interest coverage is about 7x, so there is no urgent short-term solvency issue. The real question is not "will something happen immediately," but "if scoring competition intensifies and growth slows, will financial flexibility over the next three to five years still be ample?"

On ROE, PB, and ROIC, I need to be very clear: FICO's book equity is already negative, so ROE and PB are highly distorted here and cannot be core tools for judging cheapness or quality. Fiscal Q2 2026 investor materials show total assets of about $2.048 billion, total liabilities of about $4.150 billion, and shareholders' equity of -$2.102 billion. Under this capital structure, traditional ROE/PB can easily lead to misleading conclusions. For FICO, the more meaningful metrics are segment operating margin, free cash flow, share count reduction, and sustainable pricing power under policy competition.

Now look at Owner Earnings. Under management's commonly used definition, TTM free cash flow is about $867 million. But I do not want to mechanically treat all stock-based compensation as an "ignorable non-cash item." In fiscal 2025, company stock-based compensation expense was $156.7 million. Using FY2025 plus the first half of fiscal 2026 minus the first half of fiscal 2025, TTM stock-based compensation is roughly $164 million. Therefore, 【Assumption】 I use a more conservative owner earnings approximation: Conservative Owner Earnings ≈ TTM free cash flow $867 million - TTM stock-based compensation $164 million = about $703 million. At the current market capitalization, that equals about 43x conservative Owner Earnings. Even without deducting stock-based compensation and using free cash flow directly, the multiple is still about 35x. For a company that is already quite mature and now faces a new variable in mortgage scoring competition, this is not a cheap multiple.

【Opinion】 Therefore, my conclusion on financial quality is: This company is not driven by accounting profits, but by real cash profits; its growth does not require large amounts of incremental capital investment; it broadly fits the model of "the more it grows, the more profitable it becomes, rather than the more it grows, the more cash it needs"; but because of high-priced buybacks and higher debt in recent years, the way shareholders enjoy cash flow increasingly depends on the premise that "future per-share value must continue to grow rapidly."

Valuation and Margin of Safety

I value it in three steps, and I will state the assumptions rather than only report the conclusion.

First, use an owner earnings discount method. 【Assumption】 I set the current "real cash capacity distributable to shareholders" conservatively at around $700 million, because I use the TTM free cash flow definition but treat stock-based compensation as a real economic cost. At the same time, I do not directly capitalize all of the recent strong mortgage environment and price increases into permanent high growth. For the discount rate, considering the 10-year U.S. Treasury yield of about 4.50%, the effective yield on AAA U.S. corporate bonds of about 5.02%, and FICO's continued regulatory competition, customer concentration, and leveraged buyback risks, I use an equity discount rate range of 8.5%-10%.

These are rough results based on the current share count. This is a valuation that explicitly writes good outcomes over the next decade into the model, not a guess. From this, the more practical ranges are: conservative intrinsic value of about $550-$650, reasonable intrinsic value of about $800-$950, and optimistic intrinsic value of about $1,150-$1,300. At the current share price of $1,278, it is about 35%-60% above my neutral value and already close to, or even slightly above, my optimistic scenario.

Now look at the relative valuation method. The most direct scoring competitor is VantageScore, but for public market valuation comparisons, I can only use listed comparable companies: Equifax, TransUnion, Moody's, S&P Global, and Verisk. Around May 27, 2026, their trailing P/E ratios were roughly: FICO 40.5x, EFX 28.8x, TRU 19.6x, MCO 32.4x, SPGI 26.3x, VRSK 26.1x. In other words, FICO currently trades significantly above closer credit infrastructure comparables and above most excellent data/analytics leaders. Meanwhile, based on this report's calculation, FICO itself trades at about 35x TTM FCF and about 43x conservative Owner Earnings, while PB is almost meaningless for it because book equity is negative. 【Opinion】 This is not "peers are all expensive, so FICO is not expensive." It is the opposite: "FICO is excellent, so the market has already paid a higher price in advance."

The third method is the asset/liquidation value method. For a business like FICO, its importance is actually high because it tells you this: the stock has almost no book asset safety cushion. As of March 31, 2026, total assets were about $2.048 billion, total liabilities about $4.150 billion, and shareholders' equity -$2.102 billion. Therefore, if you try to look for "bottom support" from net cash, net tangible assets, or liquidation value, the answer is: there is almost none. This does not mean the company is poor. Instead, it shows that the market is pricing it mainly for intangible assets and future cash flows. But it also means that if the moat is weakened and valuation multiples compress, there is no hard book-value floor to support you.

Putting the three methods together, I reach the following conclusion:

The "ideal buy price" here is not a guess. It is derived by applying a 25%-30% margin of safety to the neutral value range. For a conservative long-term investor, I do not think this step can be skipped.

Therefore, the answer on margin of safety is direct: The current price is not cheap enough. The most fragile assumption in the valuation is the market's default belief that the high growth and extremely high margins of Scores can last for a long time in a new competitive era. If growth is meaningfully below expectations, or if the valuation multiple returns from today's high level to a more normal level, investors may still earn very ordinary or even low long-term returns even if the business remains excellent.

Risks, Bear Case, and Comparison

The most important risk is not "quarterly earnings volatility," but where permanent capital loss could come from.

First, regulatory and competitive risk. In April 2026, the FHFA formally moved mortgage credit scoring into a new competitive implementation stage, with both VantageScore 4.0 and FICO 10T entering the implementation path. This means FICO's historical advantage in U.S. mortgage scoring can no longer simply be viewed as an unchallenged institutional position. If future adoption by lenders, GSEs, or FHA changes materially, both FICO's pricing power and volumes could come under pressure.

Second, customer concentration and channel dependence risk. A large amount of FICO's revenue is distributed through the three major credit bureaus, Experian, Equifax, and TransUnion. The company disclosed that these three contributed 51% of fiscal 2025 revenue, and this rose further to 58% in the first half of fiscal 2026. As of the end of March 2026, three customers already accounted for more than 10% of accounts receivable. These firms are the most important channel partners, but they may also create pressure in negotiation, revenue sharing, and competitive policy.

Third, software platform execution risk. Platform ARR is certainly growing, but Non-Platform ARR is also declining. The Software segment margin is much lower than Scores, and the Software segment operating margin fell from 32% in 2025 to 30%, and was about 29% in Q2 2026. If Platform cannot successfully turn migration, cross-selling, and scale effects into higher profit, then its reinforcement of the scoring moat will be weaker than the market imagines.

Fourth, overvaluation risk. FICO's current trailing P/E is 40.5x, while the FCF yield is only about 2.9% and the conservative Owner Earnings yield is about 2.3%, both below the 10-year Treasury yield of 4.50% and the AAA corporate bond yield of 5.02%. Put differently, if you buy it today, you are not buying "ready-made cash flow return." You are buying the assumption that "the company must remain very strong for many years into the future." If growth, competitive structure, or market preference fails to support that assumption, this high valuation will hurt holders.

Fifth, leverage and buyback risk. FICO does not have an immediately out-of-control leverage problem, but it is now a company that "uses excellent cash flow to support higher leverage and places buybacks at the center of capital allocation." If the company continues to borrow and repurchase shares at high valuation levels while regulatory competition slows the core business, buybacks could shift from "enhancing per-share value" to "amplifying shareholder losses."

Sixth, legal and reputational risk. The company's 10-K discloses that some claims in antitrust litigation related to Section 2 of the Sherman Act remain in subsequent proceedings. At this stage, this is not my core reason for rejecting the investment, but it reinforces one fact: when a company has extremely strong market position and pricing power, regulatory and legal attention naturally rises.

If I had to write the strongest bear case, it would be this: FICO may be a truly great company, but the market is pricing a "high-quality, partly regulation-protected scoring franchise" as an "almost permanently undisturbed compounding machine." At exactly this point, mortgage scoring regulation is starting to encourage competition, revenue concentration among the three major credit bureaus is rising, and the software platform is not yet strong enough to fully offset possible institutional disturbance in the core scoring business. Yet the company continues to use higher debt for high-priced buybacks. As a result, even if the enterprise itself is not bad, shareholders may suffer poor long-term returns because they paid too high a price.

What facts would overturn the current cautious judgment and make me more willing to raise the rating? I would watch these: If over the next two to three years FICO can still maintain 85%+ operating margin in the Scores segment after mortgage scoring competition opens up, keep stable relationships with the three major credit bureaus, continue high-teens growth in Platform ARR, and gradually reduce leverage after buybacks, then I would acknowledge that this company is stronger than my cautious valuation currently implies. Conversely, what facts would make me admit that an originally bullish view was wrong? If Scores growth stalls, segment margin continues to fall below 80%, Software DBNRR and ARR weaken together, regulatory adoption clearly migrates toward alternative scores, or leverage approaches the covenant limit while the company still continues large buybacks, then this is not "valuation fluctuation," but a change in business quality itself.

Compared with other opportunities, my conclusion is also not optimistic. Compared with the strongest public comparables, FICO's business quality is no worse and may even be better than most credit data and analytics infrastructure companies, but its price is higher. Compared with broad market indexes, FICO's enterprise quality is clearly better, but the valuation cost you pay today is also far higher than for the "average company." Compared with risk-free or high-grade bonds, FICO currently gives you a lower cash yield, so it must rely on excellent growth over many future years to make up the difference. 【Opinion】 If I could hold only five assets, I would not put it in the top five at the current price simply because "it is a good company."

This also explains a limitation of this report: I did not force a unified calculation of gross margin, PB, and rigorous ROIC, because FICO's negative shareholders' equity, continuous large buybacks, and capitalized internal software make these metrics strongly distorted. For this company, a more reliable framework is: segment profitability, free cash flow, customer and regulatory dependence, capital allocation discipline, and conservative discounting of Owner Earnings.

Checklist and Final Judgment

First, the checklist:

The evidence behind this checklist has already been laid out above: the business quality passes, but the purchase price does not.

In the final format requested, my conclusion is as follows.

【Final Rating】 Watch

【One-Sentence Investment Thesis】 FICO is a high-quality credit scoring franchise plus platform software company, but the current share price has prepaid too much for that excellence and leaves insufficient margin of safety.

【Core Bullish Reasons】 FICO Score remains deeply embedded in the U.S. consumer credit system, and the Scores business has extremely high margins, low capex, and real pricing power. Free cash flow has exceeded net income over the past five years, cash quality is excellent, and capital intensity is very low. The software platform is not an empty narrative. Platform ARR has grown from $263.6 million at the end of 2025 to $349 million in fiscal Q2 2026. The governance framework is generally good, management and shareholder interests are basically aligned, and continuous buybacks have increased per-share ownership of the business.

【Core Bearish Reasons】 Mortgage scoring competition entered a new regulatory implementation stage in 2026, narrowing the edge of the core moat's institutional exclusivity. Revenue concentration among the three major credit bureaus is high, reaching 58% of revenue in the first half of fiscal 2026, showing clear customer/channel dependence. In recent years, large buybacks have often occurred at high prices, while debt has risen significantly, leaving insufficient evidence of valuation discipline in capital allocation. The current valuation is already close to an optimistic scenario, with PE, P/FCF, and conservative Owner Earnings multiples all elevated.

【Key Assumptions】 FICO can still maintain high barriers and high margins in Scores under the new competitive environment. The three major credit bureaus will remain stable distribution channels and will not materially squeeze FICO's economics. Platform ARR growth can eventually turn into higher, not lower, Software segment profitability. Future debt and buyback cadence will not turn against shareholders if growth slows.

【Fair Buy Price】 My ideal buy range is $550-$700/share, which applies a roughly 25%-30% margin of safety to the $800-$950/share reasonable value range. For shareholders who already hold it with a very low cost basis, $700-$950/share can be viewed as an "acceptable hold range." But above $1,100 is already clearly unfriendly to conservative new capital, and the current $1,278 is closer to an optimistic scenario than a neutral one.

【Target Holding Period】 More than 10 years. But the prerequisite is that you are not starting this holding period at a price that leaves almost no room for mistakes.

【Expected Annualized Return】 Based on the three scenarios in this report, if you buy at the current price and hold for the long term, the conservative scenario is roughly 0%-2% per year, the neutral scenario about 4%-6% per year, and the optimistic scenario about 8%-10% per year. This is not because the company is bad, but because today's pricing is already very high.

【Maximum Loss Risk】 If the next few years bring a combination of "mortgage scoring competition erosion + lower Scores growth and margins + software platform failing to fill the gap + valuation multiple normalization," a 50%-65% permanent capital loss in the share price is not unimaginable. For a negative-equity, high-intangible-value company like this, the biggest downside does not come from near-term bankruptcy, but from buying at a high valuation when the enterprise remains good, yet far less perfect than the market previously imagined.

【Tracking Indicators】 The most important items to track are: Scores segment revenue growth; Scores segment operating margin; revenue share from the three major credit bureaus; mortgage scoring implementation and adoption progress; Platform ARR growth; Software DBNRR; the gap between free cash flow and stock-based compensation; net debt and leverage; average buyback price and buyback amount; and any antitrust/regulatory developments.

【Signals That Trigger Reassessment】 Adoption of VantageScore/FICO 10T in the mortgage market is materially faster than expected. Scores segment operating margin stays below 80%. Revenue concentration among the three major credit bureaus keeps rising while FICO cannot maintain equivalent pricing power. Platform ARR slows materially, or Software retention falls below 100% and stays there. Leverage approaches the covenant limit while the company continues large debt-funded buybacks. Free cash flow begins to stay systematically below net income, or receivables/DSO deteriorate rather than improve.

【Final Recommendation】 Calmly, with restraint and a long-term orientation: FICO deserves respect and long-term tracking, but it is not worth giving up price discipline just to own a good company. For new capital, my recommendation is wait. For existing low-cost positions, I would lean toward continuing to hold while closely tracking regulatory competition and buyback discipline, rather than adding aggressively because of short-term high growth. The easiest mistake right now is not underestimating FICO, but mistaking an "excellent enterprise" for a "stock worth buying at any time."

This report is based on public information and does not constitute investment advice. Markets carry risk; invest with caution.