The consumer-lending industry is ripe for disruption. Application and approval methods have been relatively unchanged for decades.
In this segment from "The Five," recorded on Dec. 14, Fool.com contributor Trevor Jennewine highlights one stock that is using artificial intelligence to improve consumer lending.
Trevor Jennewine: One of the trends I really like is artificial intelligence, and I'm going to go with Upstart (UPST +1.11%) as a good way to invest in that trend. I'm sure that a lot of Foolish investors are familiar with Upstart, but it's an AI powered lending platform. The company's mission is to improve access to consumer credit and also to reduce the associated costs and risks for lenders. Basically, its platform connects consumers to lending partners like banks and credit unions. One of the drivers for this is that traditional credit models use up to about 30 variables most of the time when they're deciding who gets a loan and what interest rate they will pay. Upstart's management team, which is led by co-founder and CEO David Girouard, the former President of Google Enterprise.
They believe that methodology is flawed. It's not including enough data to get an accurate picture of risks. For instance, they mentioned that 80 percent of Americans who have borrowed money have never defaulted on a loan, but only 48 percent have access to prime credit or the interest rate. That's the interest rate that financial institutions charge their best customers. The current system hurts banks and borrowers in a few ways. Some creditworthy applicants are being turned away and then other approved applicants are being charged too much. Upstart uses artificial intelligence to make the process better. It captures about 1,600 data points per borrower, measures that information against 10.5 million repayment events. That number is always going up. That creates a network effect.
As you get more borrowers, you have more data. Each time someone makes or misses a payment, the AI models get a little bit better at predicting the risk of default. That network effect should be a significant growth driver in the years ahead. More importantly, the company has some results to back it up. Am going to show us another slide here. In one study where they looked at a few different banks and they held the approval rates constant, Upstart's platform was able to reduce defaults by about 75 percent. Then that also works the other way. If you hold your loss rates constantly or your default rates constant, they can expand the number of approvals by 173 percent. There's a nice middle ground in there where you can approve more borrowers and you can still lower your loss rates. That's a pretty compelling value proposition. The financial picture looks pretty solid revenues, 621 million over the last 12 months, that's up 190 percent. They're free-cash flow positive.
In fact, they're actually positive on a GAAP basis. But when you look at transactions volume, their platform is used to originate $8.9 billion in loans over the last year. That figure is up 175 percent, but it is a small fraction of the $753 billion market opportunity right now, $753 million is a very small fraction of that. That just includes personal loans and auto loans. The company is also mentioned going into mortgages and other lending verticals. That could push their market opportunity eventually to over five trillion dollars. I think there's plenty of room for this business to grow. I want to say the stock has done about 65 percent right now from a tie. If that's interesting to you, now might be a good time to buy a few shares of Upstart
