Fintech company Upstart Holdings (UPST 2.76%) has been one of Wall Street's most volatile stocks; in just under two years since going public, the stock's gone from $20 to $400 back down again -- a stressful ride indeed!
The company is still young and has to prove to investors that it has the staying power to not only survive but thrive over the coming years. There is still a lot of work to be done on that front, but Upstart has seemingly found a niche that could help it to grow and establish itself enough to win back investors.
Progress to be made
Upstart uses artificial intelligence to displace a credit score in approving borrowers for consumer loans. The company argues that credit scores are an outdated technology that paints borrowers with too broad a stroke and skips over worthy applicants in the process. The company says its algorithms can approve loans at the same rate but suffer 75% fewer defaults.
Upstart works with a partner network of banks and credit unions to place its AI technology within the lender's existing program or to originate loans directly and sell them to investors shortly after. But getting lenders to trust a new technology over something that has been the standard for decades can be challenging. However, Upstart is making progress; the company's partner network had just 25 lenders a year ago but nearly tripled that to 71 as of the second quarter of this year.
There's a degree of networking in the lending industry; the continued accumulation of partners seems to reflect positive sentiment around Upstart and the value its product brings to the table. The more partnerships Upstart can establish, the better. A reversal of that trend, on the other hand, would be a huge red flag for investors.
Getting traction in a $2.1 trillion lending market
This networking idea might be particularly relevant among credit unions. There are over 4,800 credit unions in the United States, with combined assets of $2.1 trillion. The National Association of Federally-Insured Credit Unions (NAFCU) announced last year that Upstart had become a preferred partner for its members. Earlier this month, the NAFCU recognized Upstart, announcing an innovation award.
Such endorsements could go a long way for Upstart. Lending is a fragmented industry, and most banks and credit unions lack the financial and technological resources to compete with the large national banks. But Upstart presents an opportunity for smaller unions to leverage new technologies which allow these more local entities to compete with bigger names in the space.
Sure, a company like Bank of America may eventually create competing technology to what Upstart does. But Upstart doesn't need to partner with the giant banks; there's plenty of opportunity in the thousands of smaller lenders across America. Bank of America is worth $250 billion in market cap and has the deep pockets to build in-house technology. Smaller lenders, however, don't have those same advantages.
The stock's valuation reflects the risk
It's evident in hindsight, but a euphoric market pushed Upstart to $400 per share, which seems silly now that the stock is just over $20. The dramatic, rapid rise of interest rates has thrown a wrench into Upstart's business, which has stated it will lean on its balance sheet more to support originated loans. At the same time, it's establishing committed loan funding versus taking the loans to market and trying to find buyers.
The stock's valuation has utterly collapsed; the price-to-earnings ratio (P/E) has fallen from more than 400 to 25, and the price-to-sales ratio (P/S) from more than 45 to less than 2:
UPST PE Ratio data by YCharts
The company must first endure the current economic environment. With $914 million in cash on the balance sheet, Upstart seems well-positioned to make it through today's downturn. That's enough cash to cover all $628 million on its balance sheet even if every single loan defaulted, which is highly unlikely.
Upstart also has to work towards building a base of committed funding for its loan originations so that its business doesn't epxerience violent ups or downs in future market cycles due to economic factors outside the company's control.
These things could take time, but the growth of partners and endorsement of the NAFCU are signs that the product adds value to lenders. The stock could eventually reward investors for their patience if these positives continue. The thousands of credit unions out there offer plenty of opportunities for the company to grow over the coming years.
