The S&P 500 soared 26.9% last year -- its third-best performance in the last two decades -- as the economy rebounded from the onset of the pandemic. Things have gone the opposite direction in 2022. Fueled by soaring inflation and rising interest rates, the S&P 500 is down nearly 11% year-to-date, and many individual stocks have fallen sharply from their highs.
For instance, Upstart Holdings (UPST 7.52%) and Block (SQ 5.02%) have seen their share prices drop 80% and 63%, respectively. Some of that selling can be attributed to pricey valuations throughout the pandemic, but some likely comes from concerns about near-term growth in a tough macroeconomic environment. Fortunately, that creates a buying opportunity for long-term investors.
Here's what you should know.
For years, banks have built their credit models around Fair Isaac's FICO score, a construct designed to quantify creditworthiness. But the typical FICO scorecard is generated using less than 20 variables, which means banks often make lending decisions with an incomplete picture of the true risk. In turn, some borrowers are needlessly rejected, others are erroneously accepted, and many creditworthy people pay too much interest to subsidize those who will inevitably default. That's where Upstart can make a difference.
Its platform leans on big data and artificial intelligence (AI) to help lenders quantify risk more precisely. Specifically, it captures over 1,500 data points per borrower and measures them against 21.6 million past repayment events (and counting). Internal studies have shown that, compared to traditional credit models, Upstart's AI models can reduce defaults by 75% while keeping approval rates constant; alternatively, they can boost approvals by 173% while keeping default rates constant. Lenders benefit either way.
Not surprisingly, Upstart is growing at a furious pace. Last year, revenue skyrocketed 264% to $849 million, and the company generated $153 million in free cash flow, up from $10 million in 2020. But this AI-powered fintech company hasn't even scratched the surface of its true potential.
Upstart currently puts its addressable market at $820 billion, a figure that accounts for its personal and auto lending services. For context, its transaction volume totaled $11.8 billion last year, or just 1.4% of its market opportunity. But the company also plans to expand into other verticals, including the $4.6 trillion mortgage origination market, leaving a long runway for future growth.
Investors should remember that Upstart's AI models have not been tested during a down period in the credit cycle, so there is certainly risk here. But the early results are promising, and with shares trading at a reasonable 8.7 times sales, I think this growth stock is worth the risk.
Many businesses use a patchwork of hardware, software, and services to operate brick-and-mortar stores. They usually have to sign long-term contracts to obtain those systems, and they need to employ IT personnel to keep the systems in working order. Businesses that also want to sell online often need additional software from other vendors, making the situation even more complicated. That's where Block can make a difference.
Block's Square ecosystem is a cohesive set of solutions -- hardware, software, and services -- that help businesses operate across physical and digital channels. That includes tools for payment processing, customer loyalty, labor management, and financing. Block also provides point-of-sale systems designed specifically for retailers and restaurant owners, and those products have helped it gain traction with larger sellers. In Q4 2021, 66% of gross payment volume (GPV) came from sellers making over $125,000 per year, up from 56% in Q4 2019.
Block also provides financial products and services to consumers through its Cash App, a mobile app that allows users to execute a number of financial functions, including preparing taxes and sending, spending, and investing money from a single platform. In 2021, that convenience brought 44 million monthly active users to the platform, up 22% from 2020. Better yet, 31% of those users also use the Cash Card (a linked debit card), up from 26% last year. That's important because gross profit from Cash Card users is nearly fivefold higher than that of non-users.
Collectively, Block's disruptively simple approach to financial services has led to impressive financial results. In 2021, gross profit soared 62% to $4.4 billion, and the company generated $714 million in free cash flow, up from $35 million in the prior year. But Block puts its addressable market at $160 billion, leaving plenty of room for growth, and management is making smart moves.
In the past year, the company added banking services (savings and checking accounts) to its Square ecosystem, further simplifying money management for merchants on its platform. It also made it easier for Cash App users to deposit paychecks directly, an effort that should bring more money into the ecosystem. Finally, Block completed its acquisition of "buy now, pay later" specialist Afterpay in February. The company believes that move will drive growth in both ecosystems by boosting sales for Square merchants and facilitating product discovery for Cash App consumers. And with shares trading at 2.9 times sales, Block's valuation is zeroing in on a five-year low. That's why now is a good time to buy this beaten-down growth stock.