Shares of Upstart (UPST 18.59%) are sitting on a whopping gain of 353% in 2023, yet they are still trading 85% below their all-time high. How is that possible?
The stock listed publicly in 2020 at $20, surged as high as $401 in 2021, and then collapsed to a low around $12 late last year. Therefore, its 2023 return has come off an extremely low base relative to where the stock has traded previously.
You might be wondering what triggered that roller-coaster ride in the span of just three years. I'll tell you -- and explain why Upstart stock might be a buy now.
Upstart is disrupting the lending business
Upstart is an artificial intelligence (AI) software company focused on helping banks and financial institutions measure the creditworthiness of potential borrowers more accurately. It's no easy task; the company is up against Fair Isaac's FICO credit scoring system, which has been entrenched in the banking industry for more than three decades.
Unhooking lenders from the comfort of what they know is a real challenge, but Upstart's proposition is attractive. Its AI models can assess 1,600 different data points on a borrower so quickly that 84% of approvals are instant and fully automated, with no human intervention.
By comparison, FICO looks at just five core data points, and it can take a human assessor days or even weeks to come to an approval decision.
At the height of the poandemic during 2020 and 2021, interest rates were adjusted to record lows and the U.S. government flooded the economy with stimulus money. Consumers took full advantage and went on a borrowing binge.
Upstart processed a record number of loan originations, and its revenue more than tripled year over year in 2021. Its stock price followed along and hit an all-time high of $401.
But the tide turned in 2022 when those conditions reversed. Surging inflation forced the Federal Reserve to embark on the most aggressive campaign to hike interest rates in its history, and investors grew concerned that Upstart's AI models hadn't been battle tested in such a harsh economic environment.
All the while, consumer demand for credit plunged, which caused Upstart's revenue growth to flatten out.
It triggered a collapse in the stock price, sending shares as low as $12. But investors weren't the only ones panicking; Upstart's funding sources dried up, forcing the company to absorb some loans on its own balance sheet. That added a whole new dimension of risk to the business.
But Upstart is almost out of the woods
The company embarked on a mission to prove its AI models were holding up just fine. It has published a series of data points over the past year showing they're still significantly more accurate than traditional methods of assessment.
In summary, 53% fewer Upstart loans end in default compared to loans assessed by the big banks. That means Upstart's AI can write 173% more loans at the exact same default rate.
Those figures are likely to improve over time because the company continues to train its models on data generated from 90,000 new loan repayments each day. AI algorithms are like living neural networks: When those borrowers either make their repayments or default, Upstart's models learn and adjust accordingly as risks evolve.
That has profound social impacts, too. Upstart's algorithm approves 43% more Black borrowers and 46% more Hispanic borrowers than traditional methods of assessment. Plus, it approves them at a significantly lower interest rate. Not only is that great for those consumers, but it also creates an opportunity for Upstart's funding partners to access new markets that previously fell through the cracks.
This has culminated in a series of wins for the company in 2023. First, it had 99 total funding partners in the first quarter (ended March 31), which was almost double the number it had a year ago. Some of those partners committed more than $2 billion in funding, which will ensure Upstart won't have to put its balance sheet at risk again.
Second, in May, an investment fund called Castlelake agreed to buy $4 billion worth of Upstart consumer loans in a massive vote of confidence.
Why Upstart stock is a buy now
Buying a stock after it plunges 85% from its all-time high is never easy. But Upstart has stabilized its business and is in a great position to capitalize when consumers' demand for credit eventually reignites.
On that note, the company is eyeing a series of lucrative long-term opportunities. Right now, it operates in the personal loan and auto loan segments, which see about $946 billion in originations each year. For context, Upstart has originated only $32 billion loans in its history, so it hasn't even scratched the surface of those addressable markets.
But it gets better. Upstart has highlighted a $644 billion annual opportunity in small-business loans and a whopping $2.7 trillion annual opportunity in the mortgage market. The company hasn't entered either segment, but doing so would quadruple its current addressable opportunity.
Wall Street analysts expect Upstart to deliver $549 million in revenue in 2023, which would be a 34% drop compared to 2022. But the company's recent growth struggles might end there, because the Street predicts revenue will bounce back 41% to $773 million in 2024.
Considering Upstart's lending models have just proved their durability in one of the worst interest-rate shocks in history, the company could be poised for growth long into the future. That makes the 85% discount in its stock price an attractive risk-reward proposition.
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July 25, 2023 at 05:10PM
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