Upstart Holdings (UPST 3.90%) may not be a household name right now -- but give it time. Sooner or later (and probably sooner than later) there's a good chance you or someone in your household will become familiar with the young company. That's because it offers a much-needed solution to a long-standing problem that the financial industry had largely given up on solving.
In simplest terms, Upstart offers lenders a more effective method for judging a prospective borrower's creditworthiness. That task that has long been co-handled by the big three credit bureaus -- TransUnion (TRU 2.81%), Equifax (EFX 2.53%), and Experian (EXPG.Y 1.54%) -- along with Fair Isaac (FICO 3.26%), which considers the credit bureaus' data to come up with the FICO scores ultimately used by banks and other lenders when deciding whether or not to extend loans, and on what terms. However, the world has changed since FICO scores became the lending industry standard back in 1989, while the credit rating business hasn't.
Image source: Getty Images.
This growing disconnect opened a door of opportunity; Upstart's founders simply walked through it, launching the company in 2012 with a completely different kind of credit scoring in mind. Rather than relying on a number that's based on only a few factors, and that may or may not paint an accurate picture of an individual's creditworthiness, Upstart uses an artificial intelligence algorithm that looks at more than a thousand data points to figure out how likely it is an individual will repay borrowed funds. That approach works even better than the FICO score-based method. The dozens of banks and credit companies that have utilized Upstart's service are seeing 75% fewer defaults on loans they make with no fewer loan approvals.
Other lenders are catching on.
With that as the backdrop, here are the four key things current and prospective shareholders need to know about Upstart headed into 2022.
1. This is the new creditworthiness norm
Don't misread the message. Most lenders and credit card issuers still rely on FICO-based scores to decide if a consumer is a justifiable lending risk. That is changing though, even if slowly. Upstart reported in November that during the third quarter, four of its banking partners stopped considering FICO scores in favor of using its AI-based methodology.
Look for more banks and lenders to make similar decisions, for a couple of different reasons.
One of those reasons is the most obvious one -- lower loan losses. The other stems from a broad cultural movement that favors the idea of improving access to credit for people who may not be credit risks, but who simply don't have enough of a credit history to support a conventional credit score.
2. The stock is priced richly, but for growth Upstart is apt to achieve
Kudos to Upstart for bringing a real solution to a real problem to the table. And, congratulations are in order for its actual profitability -- something that eludes too many of its start-up peers. But the stock is anything but cheap. Though it expects 50% revenue growth this year will drive its annual earnings up from $1.95 per share to $2.35 per share, Upstart is still trading at a heady forward price-to-earnings ratio of 45.
This is one of those times, however, where prospective investors need to look at the probable growth more than a year down the road. Analysts expect Upstart to report a top-line result of just over $800 million for 2021, but by 2025, they see its revenue swelling to nearly $2.8 billion, lifting its earnings to $3.70 per share.
Data source: Thomson Reuters. Chart by author.
It may seem like a pie-in-the-sky outlook -- but it's hardly out of reach. TransUnion, Equifax, Experian, and Fair Isaac are now doing about $15 billion worth of annual business between them, and they're not doing a particularly great job.
3. Analysts see the value right now, even if most investors don't
Given their optimistic growth outlook, it's no surprise these same analysts are sticking with firmly bullish price targets even as the stock continues to peel back from its October peak.
As of Thursday's close, Upstart shares were priced around $107. That's around one-quarter of last year's admittedly overheated high of just over $400. But, it's also less than half the current consensus target price of $255.30. In the view of the analyst community, this stock is sporting a 140% upside if the company can just get more investors to understand and embrace its story.
4. It's a fintech, for better and worse, and a meme stock to boot
So how does a stock wind up with a stock price that is so far removed from a sensible level in the first place? In Upstart's case, two factors are working against it.
First, it's a fintech company, and fintech stocks have been running very hot or very cold as a group of late. That's not unusual. Most names within the same sector or industry move somewhat in sync, often regardless of how well or how poorly an individual company is performing. Fintechs like Block and PayPal Holdings have fallen out of favor in recent months, dragging Upstart lower with them. As long as the group remains seen as offering more risk than reward, Upstart shares will struggle to recover. The good news is that once fintechs become hot again, Upstart could easily lead that rally.
Second, Upstart has become something of a meme stock, making it a target of traders looking to artificially push or pull a stock's price away from what could be considered normal. Its volatility hasn't been quite as over-the-top as meme stocks like GameStop or AMC. However, those traders have been putting pressure on the stock, creating the kind of volatility that makes it a tough equity for long-termers to own.
Patience will pay off
While Upstart is down and seemingly out, don't read too much into its recent price action, and don't worry that the downtrend will last forever. Time will allow the underlying business's story to spread, and meanwhile, the company will continue to grow. Meme stock traders will also lose interest over time, as their coordinated efforts have less and less impact. Indeed, long-term investors who can truly commit to a holding (and ignore the short-term oscillations) may find Upstart's pullback over the past few months has created a fantastic entry point into what is a great growth prospect.
