After a quick run-up early this year, the S&P 500 has lost some of its gains. Economists are walking back some predictions for easing inflation and interest rate cuts, and it's unclear where the economy will be by the end of 2024.
It's a good reminder that what happens in the world and the economy is never a given. When you consider stocks that could rally when the economy improves, that needs a lot of context. Is it likely to rally because of purely external issues? Will it jump despite operational deficiencies? How long can a company benefit from an economic shift?
Upstart Holdings (UPST -1.32%) demonstrated rapid growth before inflation hit and interest rates soared. Even as investors became enamored and the stock skyrocketed, some remained skeptical about how Upstart could perform under more challenging conditions. Indeed, the business went from booming to bust. Even though you could argue that it will recover when the economy does, it still looks too risky to buy right now.
Is Upstart's model better?
Upstart operates a credit evaluation platform driven by artificial intelligence (AI). Its robust data analytics and machine learning algorithms give it powerful abilities to make more accurate assessments about borrowers than the traditional credit scoring models, and management says that its platform can approve more loans without adding risk for lenders.
That's an exceptional advantage over standard systems. Banks make money from loans, but they have risk management in place to reduce the risk of default. It's a careful dance. That's what was so compelling about Upstart when it became a public company; it held the potential of becoming a lending-industry game-changer.
After being tested in the high-interest-rate environment, two points have emerged. One is that it can't approve loans at the same rates as in the low interest rate environment; the risk of default is higher, and Upstart's platform has a harder time identifying good candidates for loans. The second is that creditors turn to reliable and proven credit scoring models when the environment is more challenging. These aren't good developments for Upstart.
Upstart's revenue has declined for six consecutive quarters, and it swung from reporting rising profit to net losses. The losses have been narrowing in recent quarters, and management is projecting sales to increase about 20% year over year in the 2024 first quarter. But as long as interest rates remain high, it expects pressure.
Is this an internal or an external issue?
Investors were still wild about Upstart last year as sales plunged. Every time it reported some kind of progress, investors pushed the price up, and it was also a popularly shorted stock by investors trying to profit from falling share prices. Upstart stock gained as much as 400% last year and ended the year up 200%, but it's down 46% in 2024. In other words, it's volatile.
If you look 20 years down the line, Upstart may be in a good place, and investors might be sitting on big gains if they buy Upstart stock now. As it gathers more data points, its algorithms should improve and produce even better results.
But there are a lot of unknowns here. It hasn't had a long enough track record with positive results for investors to be fully confident that it can produce them consistently even under better conditions. With inflation stubbornly high, interest rates haven't been cut as expected, and they may stay elevated for a while. The low interest rates Upstart benefited from early in the pandemic might be a thing of the past, and they may not return for some time -- if ever. If Upstart can't perform well under those conditions, its model might not be compelling.
At the current price, Upstart trades at a price-to-sales of 4, which isn't incredibly cheap. We're talking about a company that's reporting sales declines and net losses with an outlook for further pressure. There's time to reconsider Upstart stock when the outlook improves, but for now, I wouldn't recommend it.
