Back in 2021, the share price trajectories for Upstart Holdings (UPST 9.01%) and PayPal Holdings (PYPL 0.79%) pointed toward each growth stock eventually hitting $1,000 per share. Less than a year later, both stocks are trading for well under $100 a share. A variety of macroeconomic factors out of their control and concerns about slowing growth are mostly to blame for the quick reversal in fortune. But there is an argument to be made that these reversals can be set back on a positive path.
Artificial intelligence (AI) lending platform Upstart and multinational fintech PayPal still have incredibly strong businesses, despite what the wild stock ride might imply. Each stock now offers an alluring risk/reward prospect, thanks to their lower valuations. Let me explain.
Despite posting year-over-year revenue growth of 156% during its first-quarter 2022 earnings call, this AI and machine learning credit solutions company saw a steep 50%-plus drop in share price after the report's release. It has been hampered by disappointing guidance for Q2 and for 2022 overall in an economic environment that expects to see rising interest rates and potentially higher loan default rates.
Complicating matters is that the value of loans that the company carries on its books grew from $250 million at year-end 2021 to nearly $600 million in Q1. Upstart is not generally a lender. It assesses loan applicants and funds its loans through its banking partners, capital markets, and institutional investors, removing the loans from the company's books. The lenders pay Upstart a fee for the service. The additional loans currently on its books are part of research and development efforts related to its new automotive lending segment. Considering Upstart and its management originally prided itself on not being closely tied to credit risk, this rapidly rising loan balance spooked investors.
But knowing that these loans are just part of R&D is why am I comfortable saying Upstart is one of my favorite stocks under $100 to buy. Upstart has historically kept its credit-risk exposure low. The sudden jump in interest rates has just required Upstart to take more time to assess and adjust its AI models to account for the new rates. The adjustments led to a lag in how long it holds the loans before selling them to a lender. This situation should prove to be temporary.
Management has said it is looking to automate this process to reduce the lag time and avoid future issues of so many obligations on its books. CFO Sanjay Datta said that roughly $150 million of the $600 million in loans on the books tie back to this delay in loan funding. While the combination of this lag in funding and R&D loan growth should be short-term, it will be pivotal to watch this balance in the upcoming quarters.
Through its unique creditworthiness algorithms, Upstart has recorded much lower default rates over the last four years compared to traditional credit scores.
Thanks to these lower default rates, and the fact that Upstart has grown its banking and credit union customer base from 18 to 57 in just the last year, it could very quickly outgrow its cheap-looking price-to-earnings ratio of 29.
Bought up shortly after its IPO in 2002 by eBay to help its sellers and buyers manage financial transactions online, the fintech giant PayPal Holdings (PYPL 0.79%) was eventually spun off in 2015 to operate on its own again. It has blossomed into a well-diversified and tech-focused financial services behemoth. However, as with anything even remotely tech-adjacent in 2022, PayPal has seen its shares struggle mightily over the last six months.
Investors weren't pleased when Paypal reported revenue growth was slowing and only hit 7% year over year for the first quarter. A 28% year-over-year decrease in earnings per share also created some displeasure.
As far from ideal as this may be, much of this slowing growth stems from the end of its long-standing partnership with eBay in 2021. To help replace this lost revenue, PayPal has turned to acquisitions to pick up the slack. In just the last three years, PayPal has bought Honey (the online coupon aggregator), Paidy (the Japanese buy now, pay later specialist), and Happy Returns (a reverse logistics provider) -- all while rolling out a new digital wallet. These additions combine with the company's continued efforts to build out PayPal and Venmo to their fullest extent and provide users with a seemingly endless list of financial capabilities.
Because all of these new growth avenues are not yet fully up and running, PayPal's President and CEO Dan Schulman explained that the company would rein in its international expansion to focus on integrating these new companies and reinforcing the company's core offerings. Seeing that PayPal has watched its profit margin slide from 23% to 14% over the last year, this focus on streamlining the company's core operations -- while integrating the new acquisitions -- could prove to be a shrewd move.
As this profit margin eventually stabilizes and begins rising again as the impact of eBay's loss fades away, its massive active account base of 429 million users should power its stock higher. With management guiding for revenue growth of 11% to 13% for 2022, PayPal stock looks enticing as it is trading at just 25 times earnings.
Two tantalizing valuations
PayPal and Upstart trade at a respective 25 and 29 times earnings, but the following chart puts the dramatic nature of how quickly these valuations dropped in perspective.
Since the underlying operations within both companies still seem stable -- despite the temporary challenges facing the companies -- these plunges in valuation could offer a great opportunity for investors to buy two of the best stocks trading below $100.