Upstart (UPST -0.78%) has been taking the lending world by storm with its artificial-intelligence-based loan approval engine. The company uses thousands of data points to gauge people's creditworthiness for personal loans -- and now auto loans -- but it leaves out one of the major metrics that has historically been used for that purpose: the FICO-based credit score. Upstart is looking to provide a better alternative to the traditional credit score, which for many people poorly represents the actual risk they pose to a lender.
What's special about Upstart is that it simply sells its decisions to banks looking to lend to consumers who have lower credit scores. As such, 94% of its revenue has no credit risk. The company reported its fourth-quarter earnings on Feb. 15, and the strong results showed that it has a viable route to becoming the new financial industry standard for determining creditworthiness. This stock is one that I wouldn't even think about selling, and I might even buy more soon.
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1. It's seeing rapid adoption
At the end of the third quarter, Upstart had 31 banking partners. That number grew 35% sequentially to 42 by the end of Q4, and those partners originated almost 500,000 loans with a face amount of $4 billion using its artificial intelligence engine. As a result, the company's revenue continues to grow like crazy -- up 252% year over year in Q4 to $305 million.
What is especially impressive about Upstart's increasing popularity is that for a growing number of partners, its system is actually replacing credit scores, not just supplementing them.
The company now has seven bank clients that have removed all traditional credit score requirements for would-be borrowers -- up from four in Q3 -- likely because they have recognized that Upwork's AI is more accurate than the legacy method.
2. Its profitability growth is impressive
Upstart's combination of soaring revenue and an impressive level of automation has allowed it to increase its net income and free cash flow at much faster rates than its top line. At this point, the platform automatically approves 70% of the loans it processes, so it requires little time and little human capital to generate revenue from them. That leaves more money flowing down from the top line to the bottom line. In Q4, the company reported $59 million in earnings -- a net income margin of almost 20%. Upstart also reported that its free cash flow for the full year grew by 1,430% to $153 million.
This shows that it's successfully capitalizing on its revenue growth, and that this cash will allow Upstart to invest heavily back into itself. Previously, it has routed large outlays into research and the refinement of its AI engine, as well as toward marketing. The company could also spend as much as $400 million on stock buybacks. Management has said that if it believes the company's shares are undervalued, it wants to be able to capitalize on that, and also reward shareholders.
3. It's bringing its successful formula into new markets
Upstart sees clear opportunities to expand its addressable market. The company announced its initial foray in auto loans this quarter, with more than 410 dealership locations using its determinations and 10 banking partners. This encouraging level of early adoption made management comfortable enough to estimate that its auto loan volume for 2022 could reach $1.5 billion.
That's relatively small compared to its total loan volume in 2021 of $11.7 billion -- but management sees auto loans as a major growth opportunity. Chief Executive Officer Dave Girouard, speaking on the company's earnings conference call, said that he sees its auto loan segment today as being in a similar place to where its personal loan business was in 2019. For reference, since Q4 2019, the company's personal loan volume has grown 310%.
Why I am buying more (and definitely not selling)
Chief Financial Officer Sanjay Datta, also speaking on the conference call, said that the company is seeing a return to normalcy when it comes to default rates. It had anticipated higher loan delinquencies as a result of a slowing economy after the pandemic, but Datta said that he does not expect increasing default rates to hurt the company. For investors worried about how Upstart will perform in a down economy, this is a great sign. It shows that its AI seems to be accurate in its approval decisions even as defaults broadly increase -- which has been a question in the past.
With the fog around that potential major risk starting to clear up, this might be a great time to add shares of Upstart to your portfolio. Management forecast $1.4 billion in 2022 revenue, meaning the shares trade at just 8.5 times forward sales -- a major bargain for a company growing at triple-digit percentage rates. That low price is particularly appealing given the company's jaw-dropping performance, which is why I will likely be buying shares soon.
