As we get closer to the end of 2022, fintech is still floundering. Cathie Wood's ARK Invest Fintech Innovation exchange-traded fund, for example, is down 57% this year.
Many fintech stocks have disappointed as their high growth streaks come to an end. But at least some of the slowdown looks like a temporary pause in a rough economy, and big gains might be just over the horizon. Upstart (UPST -0.58%) investors have lost a lot this year, with the stock down 83% in 2022. But in 10 years' time, it could be a huge winner. Newcomer Pagaya (PGY -5.32%), which is very similar to Upstart, is up slightly since it went public through a special purpose acquisition company deal in June.
These companies have very similar business models, and they both have strong growth prospects. Which stock is more likely to gain five times its price first?
Upstart: Beaten down by new challenges
Upstart and Pagaya both offer artificial intelligence (AI)-based credit scoring systems to expand credit for borrowers without compromising risk to lenders.
It's ironic to call Upstart the more established of the two stocks, since it only went public at the end of 2020. But it's taken shareholders for quite a ride since then, and nearly two years is longer than three months.
When it went public, Upstart was posting fabulous growth. That got as high as a four-digit, year-over-year sales growth number in one quarter last year. But it's been facing challenges as the economy has soured. Revenue growth slowed to 18% year over year in the 2022 second quarter after growing more than 1,000% last year, with a $32 million loss after many quarters of profits. Management is also guiding for a further revenue slowdown in the third quarter.
This stunning fall reveals a potential crack in the company's model, which it paints as wholly superior to traditional credit scoring models. Upstart says, for example, that using its model, credit partners can approve 75% more loans at the same rates of default.
However, in the current environment, where interest rates are being raised and the risk of default is higher, Upstart's model may not offer the same advantages to lenders. Lenders are being more careful about approvals, and Upstart isn't taking in as much business as loan approvals slow down.
Management insists that its model is better and will outperform other loans over time. However, like bank stocks, which perform cyclically in line with the economy, it is susceptible to economic trends in the short term. Management reassured investors that it's a capital-light model with high margins and lots of cash to make it, though.
But it's a risky stock to own right now. It's still a relatively young company, and machine learning means that it will probably get better over time, but that's important to keep in mind -- it will take time.
Pagaya: Growing faster?
Whereas Upstart is focused on personal and car loans, with plans to enter mortgages next year and then other areas, Pagaya already has its finger in many pies. It counts Visa as one of its credit card partners, and it works with personal loans, auto loans, credit cards, and real estate.
It also boasts its differentiated funding model, saying it raises cash even before it approves funding. That was an issue for Upstart in the first quarter, when it took some loans to hold on its balance sheet when funding began to dry up. It's an advantage for Pagaya.
This has resulted in robust growth even through the current volatile macroeconomy. Revenue increased 83% year over year to $352 million in the 2022 second quarter, with network volume up 79%. Upstart posted $228 million in second-quarter revenue. Pagaya's net loss ballooned from $6 million last year to $146 million this year, with increased expenses due to scaling and costs related to the initial public offering.
Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) fell from $7 million last year to $5 million this year. Management is guiding for $700 million to $725 million in third-quarter revenue and a wide range for adjusted EBITDA of a $20 million loss to $10 in earnings. That's compared with Upstart's expected $170 million in revenue and $0 in adjusted EBITDA.
Pagaya says its AI-powered system identified changes early in the interest rate hike cycle and responded accordingly, adapting its approvals and resulting in a better default rate. It says that the benchmark delinquency rate for unsecured personal loans of more than 30 days is 2.18%, while its own is 1.72%.
Which stock is likely to gain 400% faster?
Upstart has the misfortune of demonstrating falling revenue growth while Pagaya is just starting out. Investors are pessimistic about Upstart stock right now, while Pagaya is more of an unknown -- it's only posted one earnings report since it went public. And that report shows a company with a lot of promise. Based on this limited data, Pagaya looks stronger right now.
In this type of environment, though, it's not so likely that either of these companies will gain five-fold in the near future. But they both have the potential to do so in the long run.
