3 Stocks On My Watchlist For 2025
It's essential for investors to develop and maintain a well-curated watchlist. Today's article discusses what I'm watching.
Dear Readers,
Welcome back to the Quality Equities newsletter.
As 2024 comes to a close and we look ahead to the new year, investors and market analysts are actively sharing their projections for stock market performance in 2025. Regardless of how the major market indices fare, it's essential for investors to develop and maintain a well-curated watchlist. Such a watchlist enables thoughtful investors to identify and evaluate promising companies, positioning themselves to seize opportunities should the market offer compelling conditions for acquiring shares.
In today’s issue, I spotlight three exceptional companies on my watchlist. Each company operates a robust business model with strong fundamentals and impressive free cash flow generation abilities. They consistently return significant capital to investors through buybacks or dividends, demonstrating a commitment to shareholder value. Additionally, each company exhibits key attributes I prioritize, such as pricing power and high ROIC, which further underscores their quality.
These are businesses I’d be thrilled to own, and I plan to invest in them if the market presents an attractive entry point.
FICO 0.00%↑ Fair Isaac
Fair Isaac (FICO) is a leading analytics and software company best known for its widely adopted credit scoring system that lenders use to evaluate consumer credit risk. It functions as a virtual monopoly within the industry, granting it substantial pricing power and a resilient competitive edge.
FICO generates revenue by licensing its credit scoring models to financial institutions and credit bureaus, providing software solutions for risk management, fraud detection, and operational optimization, and offering consulting services tailored to client needs. Its business model uses proprietary analytics, mathematical models and scalable software to deliver recurring revenue and value to industries dependent on data-driven decision-making. FICO is a capital-light, high-margin business, which contributes to its strong financial performance and efficient use of resources. Its ability to generate highly predictable and steadily growing earnings makes it an incredibly attractive company.
Dev Kantesaria of Valley Forge Capital Management described FICO as “one of the highest-quality business models on the planet”, and I completely agree. It’d be difficult to design a better business.
One notable concern with FICO is its current valuation, which positions it as an undeniably expensive stock at present levels.
The company is trading at a modest 1.26% free cash flow yield (TTM), reflecting elevated market expectations. Based on a reverse DCF analysis using a 10% discount rate, the market appears to be pricing in an ambitious 10-year free cash flow CAGR of 26.85%. While FICO is undeniably a high-quality company, such a growth assumption seems overly optimistic.
I intend to remain disciplined and patient, waiting for a more favorable entry point to purchase FICO shares.
MCO 0.00%↑ Moody’s
Moody's provides credit ratings, financial research, and risk analysis services. It helps investors, businesses, and governments assess creditworthiness, manage financial risks, and make informed decisions. Moody’s shares a natural duopoly with SPGI 0.00%↑ S&P Global. Today, 90% of the world’s debt carries ratings from both Moody’s and S&P Global, making these two companies high-quality tollbooths on the global debt highway.
The company operates primarily through two segments: Moody's Investors Service (MIS), which assigns credit ratings to debt instruments and issuers, and Moody's Analytics (MA), which offers data, software, and advisory services for financial risk management and economic analysis. This dual-stream approach generates revenue through a mix of subscription-based services and fees for ratings and analytics. MA also helps to mitigate the occasional cyclical fluctuations of the MIS business.
The company is trading at a relatively low but somewhat reasonable 2.69% free cash flow yield (TTM). Based on a reverse DCF analysis using a 10% discount rate, the market appears to be pricing in a 10-year free cash flow CAGR of 16.36%. Although Moody’s is valued more reasonably compared to FICO, it remains quite expensive at its current levels.
MSCI 0.00%↑ MSCI
MSCI is a global provider of investment decision-support tools for institutional investors, such as asset managers, hedge funds, and pension funds. The company delivers critical data, analytics, and tools that enable informed investment decisions.
MSCI operates through four primary business segments: Indexes, Analytics, ESG & Climate, and Private Assets. Its indices, including the MSCI World and Emerging Markets Indexes, are widely used for benchmarking portfolios and creating investment products like ETFs. The Analytics segment offers portfolio risk management and performance analysis tools, while the ESG segment focuses on sustainability-related ratings and data. The Private Assets segment provides insights for real estate and private equity investments.
MSCI generates most of its revenue through recurring subscription fees and licensing arrangements. Subscriptions, which account for a large portion of revenue, are charged for its data, analytics tools, and ESG research. Licensing fees are earned from asset managers and institutions using MSCI indices to create investment products like ETFs, with fees often tied to the assets under management of these products. Additionally, MSCI offers consulting and custom solutions, providing tailored services for institutional clients.
The company is trading at a decent 3.01% free cash flow yield (TTM). Based on a reverse DCF analysis using a 10% discount rate, the market appears to be pricing in a 10-year free cash flow CAGR of 15.21%. Of the three companies discussed today, MSCI trades at the most reasonable valuation.
Conclusion
As markets continue to evolve and valuations remain elevated, investors must maintain a disciplined approach to portfolio analysis. While current market prices may suggest demanding growth expectations for many quality companies, it’s essential for investors to develop and maintain a well-curated watchlist.
I plan to make concentrated investments into each of these companies at some point in the future when valuation levels are more attractive. Until then, I intend to remain disciplined and patient.
Thoughts on ADBE now that’s trading at attractive levels