What happened

Shares of the artificial intelligence loan platform Pagaya (PGY 5.33%) surged an incredible nearly 494% in the month of July, according to data provided by S&P Global Market Intelligence.

The company merged with and went public through a special purpose acquisition company (SPAC) in June and began trading independently later that month. Shares plunged initially from about $9.50 to $2.70 but then exploded on July 19 and have not come down since.

So what

On July 20, Pagaya submitted its registration statement with the Securities and Exchange Commission, which revealed the stock had an incredibly small float of fewer than 1 million shares.

This can happen because investors can redeem their shares before a SPAC target starts trading independently if they don't like the company. Then the existing shareholders, including the SPAC sponsors, company employees, and private placement investors, are usually under a lock-up period for a time after the business combination closes, which prevents them from selling their shares right away.

Savvy investors are often watching for post-SPAC companies with low floats so they can drive the price up and make it impossible for other investors to borrow shares and short the company. Data from Yahoo! Finance shows that the public float right now is around just 309,000 shares, despite the fact that there are close to 459 million shares outstanding.

Now what

Aside from the manipulated trading, Pagaya has garnered a decent amount of hype since announcing it would go public. The company essentially serves as the middleman between bank and fintech companies and institutional investors looking to buy consumer loans they can generate healthy returns on.

Essentially, bank and fintech partners can send loan requests to Pagaya, who will not only underwrite the loan with its artificial intelligence technology but will also sell the loan to its network of investors. The banking partners get fee income for originating and servicing the loans and can grow customers without taking on additional balance sheet risk.

But given that Pagaya lost more than $91 million in 2021 on total revenue of nearly $475 million and currently has a market cap of $19.5 billion, the valuation has clearly gotten way ahead of itself. I also suspect that Pagaya might be dealing with a lack of loan demand from its institutional investor base right now, due to how quickly interest rates have risen this year and the deteriorating economic outlook. This could force Pagaya to slow volume on its network.

Finally, eventually, the lock-up period will end and more shares of this fintech company will flood the market. I would avoid Pagaya at such a high valuation.