The last few years have been a wild time for stocks. This is especially true for recent initial public offerings (IPO). The Renaissance IPO ETF was beating the S&P 500 by over 100% at one point, but that outperformance has cratered. In fact, the exchange-traded fund is now trailing the broad market by about 20% on a three-year basis.
One stock that embodies this trend is Upstart (UPST -2.51%), which was up more than 1,900% at its peak from its late 2020 IPO. But over the last six months, the stock is down 68%.
This wild ride could provide a buying opportunity for curious investors. Is it too late to buy Upstart stock?
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What is Upstart?
Upstart is a consumer lending platform that uses artificial intelligence (AI) to, in its words, "enable effortless credit based on true risk." What does this mean in practice? Upstart has built an in-house credit lending model that is a vast improvement over the traditional methods like a credit score. Upstart then partners with banks, giving them access to the AI model when evaluating borrowers.
The banks take on all the credit risk themselves with Upstart essentially acting as a digital layer between the borrower and lender.
How does Upstart make money? Whenever one of its partner institutions makes a loan using its platform, Upstart earns a fee for facilitating the transaction. Banks are willing to give up some of what they make on the loan because of how well Upstart is able to price specific types of consumer credit loans versus the competition.
This makes things better for consumers (who get better rates), banks (which get more and less-risky loan volume), and Upstart itself (which earns fee revenue). It is this non-zero-sum outcome that has investors excited as Upstart tries to tackle the $6 trillion consumer loan market.
Growing quickly and profitably
Let's get into some numbers. In 2021, Upstart's bank partners originated 1.3 million loans totaling $11.8 billion in volume. This was up 338% from the previous year, and the volume translated to $801 million in fee revenue, up 251%. Total revenue for the year came in at $849 million, up 264%.
Clearly, Upstart is seeing great adoption rates among its bank partners right now, and investors should expect this strong growth to continue over the next few years.
However, Upstart's current bread and butter are personal loans, which make up the smallest part of the U.S. consumer loan market with "only" $96 billion in volume a year. To grow its total addressable market, Upstart has moved aggressively into automotive loans, which account for $727 billion in volume a year.
The company has 10 banks signed on to its auto lending platform. It has grown its dealership partners to 410 at the end of 2021, compared to only 111 at the end of 2020, and management expects to hit $1.5 billion in auto-financing volume in 2022. Given how large the consumer auto lending market is, investors should expect this to be a big driver of growth over the next five years or more.
And Upstart is surprisingly profitable, which is not common for a company growing this quickly. In 2021, it generated $141 million in operating income, giving it a 16.6% operating margin. The company has an extremely asset-light model and a negligible amount of loans actually sitting on its balance sheet, so investors should expect Upstart's margins to creep higher, even as growth slows and the business matures.
Thoughts on valuation
As of this writing, Upstart has a market cap of $8.7 billion. That gives the stock a trailing price-to-sales (P/S) ratio of 10.3 and a trailing price to operating income (P/OI) of about 62. Looking to 2022, management is guiding for $1.4 billion in revenue. If Upstart hits that target, its P/S multiple will come down to 6.2 by the end of this year.
Given how fast Upstart is growing, its asset-light model with strong profit potential, and the large addressable market between consumer and auto loans, I don't think inflated current sales and earnings multiples are a huge concern here. They are something to watch, no doubt, but not something that should keep you out of the stock.
With all of that in mind, it's not too late to buy Upstart stock. If you believe in management's vision, its AI model, and think annual loan volume can grow much higher than $11.8 billion a few years down the line, now would be a great time to take a position in the company.
