What happened
Shares of Upstart Holdings (UPST +0.91%), an artificial intelligence-based lending platform, plummeted 33% in May, according to data provided by S&P Global Market Intelligence. After a rough first quarter, several analysts downgraded the stock over the past month.
So what
Upstart stock has been volatile over the past few months, Reaching $400 in October before touching down at only $25 last week. Investors were willing to pay a high price for shares of what appeared to be a fast-growing, well-run and profitable company with soaring prospects and a unique, useful business.
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That began to change several months ago when the macroeconomic climate changed, and high-flying growth stocks with outrageous valuations all of a sudden didn't look as enticing. But the company's first-quarter earnings report, which was released in early May, drove a sell-off of Upstart stock that continued throughout the month.
Two main issues came to light in the earnings report. First, due to inflation and rising interest rates, it faced unexpected factors and had trouble with its pricing algorithms. That resulted in higher interest rates for some approved loans and lower loan approval rates. Since the benefit of working with its model is higher approval rates, that's basically a disaster.
The second issue was a large increase in its loan book. As a platform, it's meant to be asset light, leaving the actual loan and credit risk to the banks. But it took on more loans in what it saw as a research and development effort, and with rising interest rates, it now has a much larger credit risk on its books.
Now what
These revelations shocked the Upstart investor community, which was enamored with this company. Its first-quarter progress was actually pretty good. With 156% year-over-year sales growth, it was the fourth consecutive quarter of triple-digit growth, and with a 224% increase in net income, it was the seventh consecutive quarter of profit increases.
It has a huge addressable market between personal loans, its core business, auto loans (which it recently entered), and mortgages, its largest market at $4.5 trillion, which it plans to enter in 2023. It added 15 new banking partners in the first quarter for a total of 57, and added 115 auto dealers for a total of 525.
As of December, five out of 10 covering analysts were still saying "buy," with zero sell recommendations. Now, eight have it on hold, with two sell recommendations and only three buy recommendations. At the current price, shares are trading at 28 times trailing-12-month earnings.
Management is well aware of its issues and is addressing them. On the recent earnings call, CEO Dave Girouard said, "We've been through several disruptions in our industry over the years, and each time, Upstart gained market share and emerged a stronger company." While it's going through it again, there's risk attached to buying this stock. But with the immense opportunities, track record, and cheap price, investors should consider buying shares.
