To buy Upstart Holdings (UPST 0.13%) stock or not to buy? That has to be the question of the year for some investors. The artificial intelligence-powered credit company rocked the investing world when it exploded onto the markets last year, gaining nearly 1,000% from its first-day closing price at the end of 2020 through October 2021. Since then it's posted a spectacular decline, losing roughly 94% of its value. It now trades at a mere 14 times trailing 12-month earnings. Should the newly humbled stock make it onto your buy list? Let's examine it.
Why it got so high
Upstart offers a fresh take on credit assessment. It says that four out of five Americans have never defaulted on a loan, but don't have access to good credit because they fail credit evaluation criteria from old-fashioned assessment tools such as Fair Isaac's FICO tool, which takes a very narrow view of creditworthiness.
Upstart is trying to change that by using machine learning and evaluating many other criteria to determine creditworthiness. It claims that banks using its platform have 75% fewer defaults at the same approval rates. Its simple-to-use and simple-to-integrate model takes away many pain points for banks and customers, with 74% of applicants approved instantly.
More lenders are taking note, and banking and credit union partners increased from 18 in the first quarter of 2021 to 57 at the end of the first quarter of 2022. More than half of its business comes from one bank partner, so that's something to keep an eye on, although that's come down from more than 70% when Upstart went public.
The numbers speak for themselves. Revenue has increased by triple-digit percentages for four consecutive quarters, and one quarter even had a quadruple-digit gain. In the 2022 first quarter, revenue increased 156% over the previous year to $310 million, and net income rose to $32.7 million from $10.1 million last year.
The company recently entered the car loan market through Upstart Auto Retail, and it's been growing quickly as well. Dealership rooftops on the platform increased from 162 at the end of the 2021 first quarter to 525 at the end of the 2022 first quarter. More bank lenders are joining the platform as well.
Management sees a huge market opportunity, with $112 billion in personal loans and $751 in car loans. It also plans to enter new markets, with a $4.5 trillion market opportunity in mortgages and $644 billion in business loans.
It's no wonder investors were scooping up shares fiercely. But it's not that simple.
Why it tumbled
Upstart's share price already began to falter after the company gave what investors considered a weak outlook back in October. Triple-digit growth percentages notwithstanding, shareholders didn't appreciate the slowing projected growth.
But it got really ugly after the 2022 first-quarter earnings report in May, when the company revealed that it had added a sizable position to the loans held on its books. Upstart is essentially a platform, not a lender. The fact that it didn't have a lot of credit exposure was seen as a positive when considering Upstart as an investment. In a rising interest rate environment, with more loans on its books, the company is exposed to a higher risk of defaults. Even worse, management forecast about 55% year-over-year growth for the 2022 second quarter. More banks may be hesitant to approve loans in this kind of interest rate environment, and more customers may default. To top that off, Upstart's model has yet to be tested when rates are rising. It's not clear how well the model will be able to accurately assess creditworthiness under current macroeconomic conditions that include that highest inflation in four decades.
Finally, management gave a preliminary second-quarter update at the beginning of July with revenue coming in lower than expected and net losses soaring to between $27 million and $31 million after many quarters of profits.
Part of that projected loss was due to Upstart converting some of the loans on its books into cash. Taking the loans off its books is a positive step and demonstrates the company's willingness to tackle an emerging problem, even though it reduced revenue.
What should you do now?
You don't usually find stocks posting triple-digit growth trading this cheaply. This low price means that investors are factoring in a lot of risk here. Risk certainly exists, but management's handling of the situation inspires a lot of confidence. The next few months will be very telling. Investors who can stomach the risk should consider taking a small position, keeping the long-term picture in mind.
