Upstart (UPST -3.65%) was a stock market darling that rocketed higher during the early days of the COVID-19 pandemic. Unfortunately, the gains didn't last very long. Shares of Upstart have fallen more than 90% from their peak in 2021.
You wouldn't know it by looking at the stock price, but Upstart's artificial intelligence (AI)-powered lending platform is more popular than ever. Could this stock be a bargain at recent prices, or is it still too risky?
Before wondering if Upstart is a good stock to buy now, we should understand why the stock has been hammered mercilessly.
Upstart revamped its business model
Upstart helps lending institutions measure individual credit risk, but it isn't a lender itself. At least, it wasn't until recently.
Rapidly rising interest rates and war in Europe make it hard to predict the economy's future direction. In response, many of Upstart's lending partners have been originating fewer loans.
Upstart can't force its partners to lend more in these uncertain times, but it can bring more committed capital onto its platform and hold loans on its own balance sheet. To continue growing, that's exactly what the company intends to do. This is a big departure from the company's previous business model that specifically avoided keeping new loans on its own books.
Why I'm not too worried
There are a lot of ins and outs to consider, but it looks like Upstart's AI-powered algorithms are much better at assessing individual credit risk than a traditional FICO score from Fair Isaac Company. Since 2018, the average default rate across all loans Upstart originated is 3.6% for borrowers with FICO scores above 700. That's not necessarily bad, but Upstart has proven that it could be heaps better.
The average annual default rate for borrowers Upstart gave an A+ rating is just 1.3% when those borrowers had FICO scores below 640. For A+ grade borrowers with FICO scores of 640 or better, less than 1% default annually. In other words, Upstart's model provides significantly more precision when separating high-risk borrowers from low-risk borrowers.
All quarterly loan vintages held by partnered banks are expected to meet or exceed the target returns that were set at the time of origination. Institutions that invested in riskier loans that Upstart's partners didn't hold are also doing well. Just five out of the past 17 quarterly vintages have underperformed. Across all risk grades, Upstart-originated loans since 2018 are expected to deliver a 9.8% annualized return compared to a target of around 8%.
Upstart originates a lot of unsecured personal loans, a product that banks are generally hesitant to offer when there could be a recession on the horizon. Funding constraints were the primary reason the company reported revenue that fell from $310 million in the first quarter to $228 million in the second quarter. With more committed capital to work with, Upstart could quickly reverse this trend.
Keeping more loans on its books isn't the only way Upstart intends to grow its business. The company is entering the lucrative market for auto loans in a big way. In August, there were already 640 dealerships using Upstart Auto Retail Software, and loan originations from this new segment could accelerate. The company recently added the machine learning model that handles automated income verification for its personal loan operation into its auto loan product.
Upstart has fallen so far this year that you can scoop up the stock for just 30.6 times forward earnings estimates right now. That's a very reasonable multiple for a company that could grow by leaps and bounds once its lending partners return to their usual pace of loan origination.
In the second quarter, Upstart originated loans totaling $3.3 billion, which was 12% more than the previous year. Investors can look forward to many more years of rapid growth because the company has only scratched the surface of its total addressable market. The auto loan space alone is estimated at around $900 billion annually. With a successful track record and heaps of room to grow, this stock could deliver enormous gains over the long run.