Upstart Holdings (UPST -7.89%) is an explosive financial technology company that uses artificial intelligence (AI) to originate loans for banks. Its goal is to replace the much narrower FICO (FICO -2.13%) credit scoring system to provide a fairer lending experience to potential borrowers.
After reaching an all-time high of $401 per share in 2021, Upstart stock has progressively fallen, at one point by as much as 93% since. Investors took particular issue with the company's recent Q1 2022 earnings report, sending the stock down more than 50% on the day results were released. Let's explore the details.
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The concerns
Banks pay fees to Upstart when its artificial intelligence-powered algorithm originates a loan for them, and that's the company's primary source of revenue. Upstart is not a lender, but it has taken on some loans for research and development purposes relating to its new automotive lending segment.
However, volatile circumstances in credit markets recently pushed the company to expand its loan portfolio to $597 million in Q1 2022, up from just $252 million in the prior quarter. Investors are worried Upstart is having trouble offloading the loans to its bank partners, but in an attempt to ease concerns, the company did say it expects this to be a temporary issue.
It's worth noting that the $345 million expansion in loans represented just 7% of Upstart's $4.5 billion of originations for the quarter.
There is also some uncertainty surrounding Upstart's ability to navigate a difficult economic environment. Will its AI-driven lending model appropriately account for heightened risks from rising interest rates or higher unemployment? This is largely untested because the last few years have been so strong -- even with COVID -- thanks to mountains of stimulus from the government. But the company maintains it continues to price risk far more accurately than traditional underwriting.
Finally, Upstart reduced its 2022 revenue forecast to $1.25 billion from $1.4 billion, citing rising interest rates that will reduce demand for loans and lower approval rates.
These noteworthy issues aside, there are still plenty of reasons to be bullish on Upstart over the long term. Here are three of them.
1. Upstart is a financial powerhouse
Unlike most up-and-coming tech companies, Upstart is running a profitable operation. Its Q1 2022 result marked the seventh consecutive quarter of positive earnings per share, and growth has been staggering. The company generated $0.34 in earnings, representing a 209% year-over-year jump.
It came on the back of $310 million in revenue, an increase of 156% from the prior-year quarter. But at the very heart of these blockbuster results was $4.5 billion in transaction volume (loan originations), up 174%.
It follows a staggering run-up in revenue over the last few years.
2. The automotive loan opportunity
Upstart first began in unsecured loan originations consisting of personal loans for medical reasons and for home renovations, among other things. It's a market worth about $112 billion annually, according to the company, but in 2021 it entered the significantly larger automotive loan market. Upstart's opportunity here could exceed $751 billion a year, and it's already showing powerful growth.
Upstart measures its progress by counting dealer rooftops, or, more simply, the number of car dealerships using its Upstart Auto Retail sales and finance origination software. So far, 35 leading car brands have adopted the platform in 525 of their physical dealership locations. In addition, 13 lending partners (banks and financial institutions) have signed on to absorb Upstart's loan originations.
In Q4 2021, Upstart told investors it expected to originate $1.5 billion worth of automotive loans during 2022. It didn't reiterate or update that projection in the most recent quarter, but the rate of growth in dealer rooftops suggests its trajectory could remain on track.
However, circling back to the $597 million in loans Upstart holds on its balance sheet, further progress might be dependent on the company's ability to first offload these.
3. A growing addressable market
Finally, if Upstart successfully weathers the current storm, there could be trillions of dollars worth of opportunities on the other side. Aside from personal loans and automotive loans, the company highlighted the value of small business lending and mortgages in its recent Q1 2022 earnings presentation.
Upstart could be swimming in a pool of $6 trillion in annual originations if it eventually finds its footing in all of these markets.
Still, there is plenty of work to be done to recover from the decline in Upstart stock. The company needs to win back the trust of investors and prove it can maintain high credit quality for its bank partners. The next few quarters will be telling with respect to its ability to sell loans and prevent its balance sheet from absorbing an unsustainable load.
If it can right the ship, there's plenty of potential upside on the table. Upstart stock trades at a forward price-to-earnings multiple of just about 15, a discount to the Nasdaq 100 forward multiple of about 22. Therefore, the stock would need to rise by a third just to trade in line with the broader tech market.
