The Pareto Principle -- also called the 80/20 rule -- was first proposed back in 1896 and it has been found to hold true when applied to a number of different areas, including sports, computing, healthcare, and especially economics. One application of it in economics suggests that about 80% of the market's gains at any given time are driven by 20% of the market's stocks.
This is part of why many investing firms emphasize the need for diversification in a portfolio. No one knows for certain which stocks will be in that 20% group generating monster returns for shareholders. While there is no absolute certainty out there, we can make some strong educated guesses about which stocks are in the 20%, and it's pretty clear that Zscaler (ZS 0.30%) and Upstart Holdings (UPST 0.79%) have massive upside potential. Let's take a closer look at these two monster stocks.
1. Zscaler
Zscaler operates the largest network security cloud in the world. Its Zero Trust platform, known as a secure access service edge (SASE), accelerates and secures access to applications and infrastructure, allowing employees to connect to corporate resources and the open internet from any device or location. Moreover, by delivering security from the cloud, Zscaler eliminates the need for costly on-premise hardware.
Thanks to its first-mover status and tremendous scale, research company Gartner has recognized Zscaler as the industry leader for 11 consecutive years. During that time, the company has become a key enabler of digital transformation, helping organizations shift resources to the cloud, adopt remote work, and protect their IT ecosystem from cyberattacks. Not surprisingly, that has translated into strong financial results. Over the past year, revenue soared 61% to $970 million and free cash flow climbed 45% to $184 million.
Zscaler is well-positioned to reward patient shareholders. The company has captured a fraction of its $72 billion market opportunity, but its retention rate has exceeded 125% for the last six quarters, indicating a sticky platform and strong execution on its land-and-expand growth strategy.
More broadly, Zscaler is a long-standing leader in network security, and the company should benefit as enterprises continue to invest in digital transformation. In fact, Gartner believes 60% of enterprises will at least have plans in place to adopt SASE networks by 2025, up from just 10% in 2020. That tailwind bodes well for Zscaler, and it's why this monster growth stock is a smart long-term investment.
2. Upstart Holdings
Upstart is on a mission to improve the lending industry by reducing risk for banks and expanding consumer access to credit. Whereas traditional underwriting models rely on a limited amount of data -- often no more than 30 variables -- Upstart leans on artificial intelligence to analyze over 1,500 data points per borrower, helping banks quantify the risk of fraud and defaults more precisely.
As a caveat, Upstart's artificial intelligence (AI) models have not been tested through a down period in the credit cycle, and delinquencies are rising more quickly in the current macroeconomic environment, according to data from the Kroll Bond Rating Agency. However, internal data suggests that Upstart still outperforms traditional underwriting models across all FICO score thresholds.
Financially, Upstart is growing at a blistering pace. A total of 57 lenders now use its platform, up threefold from the prior year, and 525 dealerships use its recently launched auto lending software, also up threefold from the prior year. In turn, revenue skyrocketed 271% to $1 billion over the past year, and the young fintech company posted a profit under generally accepted accounting principles (GAAP) of $1.64 per diluted share.
On a less optimistic note, management lowered its financial outlook for the current year, citing the possibility that rising interest rates will diminish consumer demand for credit. Even if that does happen, the headwind is temporary. Investors should pay more attention to the performance of Upstart-powered loans as consumers battle high inflation. If Upstart's AI continues to produce better results than FICO-based models, this fintech company could go parabolic in the coming years.
Management puts its market opportunity at $860 billion -- a figure that comprises its personal lending and auto lending offerings -- but the company has a small-business loans product in the works, which will boost its addressable market to $1.5 trillion. That's why this growth stock is worth buying.
