We're in a stealth bear market; A first look at Fair Isaac
1) The S&P 500 Index is up a healthy 13% this year, including dividends. And it's a mere 1.9% below the all-time high it hit on August 13.
The index is only trading at 21 times current-year earnings, thanks to explosive AI-driven growth. However, the Shiller cyclically adjusted price-to-earnings ("CAPE") ratio, which uses average inflation-adjusted earnings over the past 10 years, is at 41.1 times. That's in the 99th percentile, within a whisker of the all-time high it reached in late 1999.
Normally, in this kind of market, a value guy like me would be struggling to find stocks to even look at, much less buy. But instead, I'm finding a lot of them.
That's mainly because the index's strong performance is being driven by only a handful of stocks – masking a stealth bear market among the rest...
Consider this graphic posted on X by user Compound248 on Monday:
It shows that 59% of the stocks in the S&P 500 are in a bear market – down 20% or more. It also shows that 41% are down 30%-plus and 17% are down 50%-plus.
No wonder I'm finding so many bombed-out stocks...
2) Let's take a look at one that caught my eye yesterday – credit-score company Fair Isaac (FICO), which crashed 26.5% yesterday.
The drop came after Bill Pulte – the director of the Federal Housing Finance Agency, which oversees mortgage giants Fannie Mae (FNMA) and Freddie Mac (FMCC) – said that the new, simplified structure for mortgage pricing will incorporate a direct competitor to Fair Isaac's FICO credit score.
The stock now sits at an almost four-year low, down 74% from its all-time high in November 2024, as you can see in this chart:
Before diving into the latest news and its implications for the company's earnings going forward, let's start with a "first look" at Fair Isaac's historical financials and valuation...
It has exceptional, rising gross and net income margins of 85% and 34%, respectively:
After the global financial crisis, revenue and net income have also risen strongly, with earnings per share ("EPS") rising even faster thanks to large share repurchases:
Operating cash flow has tracked net income, and nearly all of it is free cash flow ("FCF") thanks to minimal capital expenditures ("capex"):
Fair Isaac doesn't pay a dividend and hasn't made any sizeable cash acquisitions. Rather, it has used its prodigious FCF to steadily buy back stock, which was smart for many years.
But the sharp buyback increase over the past two years was poorly timed and smacks of a desperate attempt to prop up the stock, which has been declining – especially the huge $2 billion spent last quarter:
Thanks to the buybacks, Fair Isaac's diluted share count has declined by 59% – or 4.4% annually – in the past 20 years:
Share repurchases have exceeded FCF, especially after last quarter's big buyback, so net debt has risen to $5.3 billion:
This debt load is manageable for a company generating $1 billion of FCF annually. But after yesterday's news, FCF might decline, making the debt more problematic...
In summary, Fair Isaac's historical financials are among the best I've ever seen. It has sky-high margins, 21% annual EPS growth over the past 17 years, and almost no capex, leading to high and rising FCF.
But in light of the stock losing three-quarters of its value, it's now clear that the company made a big mistake in nearly tripling its net debt over the past few years to fund the huge share repurchases.
Turning to valuation, investors rewarded the company's strong growth and exceptional economic characteristics with a premium multiple. Over the past 26 years, the stock has traded at an average forward price-to-earnings (P/E) multiple of 25.2 times.
But after yesterday's crash, the stock is now trading at less than half that – only 11.9 times consensus analysts' estimates for 2027. That's the lowest it has ever been, other than during the global financial crisis, as you can see in this chart:
But circling back to the recent news, here's the rub: Pulte just yanked the wonderful near-monopoly Fair Isaac has enjoyed, so earnings will likely decline. The question every investor is grappling with is: by how much?
My team at Stansberry Research and I are going to take a closer look at Fair Isaac to determine if the company's earnings decline will be brief and shallow. If we decide to recommend the stock in our flagship newsletter, Stansberry's Investment Advisory, subscribers will be the first to know. You can become one by clicking here.
Best regards,
Whitney
P.S. I welcome your feedback – send me an e-mail by clicking here.