It's hard to believe that it was only one year ago that Upstart Holdings (UPST 7.52%) stock reached a breathtaking pinnacle of $390, which was nearly 1,000% above its opening-day market price less than a year earlier. So much has happened in the short time since then, and Upstart stock is now down a crushing 94% from that high.
At the same time, fellow financial stock Ally Financial (ALLY 4.26%) has plunged as well, although not quite as much: 48% from it's 52-week high. It recently became a Warren Buffett stock, stirring greater interest among investors.
Both of these companies are suffering from global economic pressure, and these low prices might pose opportunities -- or value traps. Which is the better buy today?
1. Upstart: The loan assessment tool for better credit decisions
Upstart took the investing world by storm at a time when growth stocks were still conquering the markets and looked like easy instruments for quick gains. There were good reasons to envision Upstart as a no-brainer money maker. It uses artificial intelligence to power its credit assessment platform, allowing partner banks and credit unions to more accurately identify a borrower's credit risk. Using that framework, it can approve more loans at the same credit risk. That puts more money to use without raising the default rate, ultimately netting more money for the bank.
Upstart's revenue exploded as more banks signed on, loan approvals took off, and banks were flooded with cash through stimulus money and a recovering economy.
What remained to be seen, however, was how well this would work in an atmosphere of rising interest rates without stimulus money, like now. Upstart's delinquency rates are rising, but management says that's across the industry, and not specific to Upstart. It also says these increasing rates are expected, and that Upstart's platform still outperforms traditional credit assessment tools. Revenue increased 18% year over year in the second quarter, decelerating from three- to four-digit percentage growth through the previous four quarters, as lenders are more reluctant to lend.
Just this week, the company announced in a regulatory filing that it's laying off 140 hourly workers, citing the "challenging economy and reduction in the volume of loans on our platform." The fourth-quarter outlook already looked pressured, and this confirms the bleak situation.
The long-term outlook still seems compelling. The company says it has a $900 billion market for its current products, and it sees a $4.2 trillion opportunity in mortgages, which it plans to enter in 2023. It has been adding many new banking and auto retail partners, such as a deal with car maker Honda announced last week.
2. Ally: A classic value stock
It's not surprising that Buffett bought shares of Ally stock. The bank stock is well established, having been around since 1919 as the financing arm of General Motors. It was spun off as its own entity, but it retains a robust auto financing unit, which in some ways competes with Upstart's auto financing program. Today it functions as a growing and popular digital bank and offers many other services such as credit cards and corporate products.
As a bank, Ally is being affected by rising interest rates and increased defaults. In the third quarter, Ally raised its provision for losses in the auto financing department and saw the charge-off rate increase, indicting higher defaults. Earnings per share fell 48% year over year. It's also expecting its net interest margin, or the spread between how much interest it makes on the deposits it holds and how much it gives to customers with accounts, to contract. However, there was also $12.3 billion in auto loan originations, demonstrating resilience in this economy and giving it income-generating opportunities. Some other positive updates were a 6% year-over-year increase in retail customers, and a $2.7 billion increase in retail deposits, to $133.9 billion.
Buffett loves bank stocks because they're typically flush with cash and power the economy, and Ally was showing that off in the third quarter. Buffett also looks for undervalued stocks, and Ally has looked cheap for a while. It's even cheaper now that there was a sell-off after the third-quarter report. Shares trade at only 4 times trailing-12-month earnings and only 0.8 times book value.
Which is the better financial stock?
Ally and Upstart are both feeling the impact of a strained economy, and both share potential for future growth. Given the higher likelihood of stability at Ally as well as its cheap valuation, I would look at Ally as the better buy overall. However, for investors who have a high appetite for risk, Upstart still looks like it offers strong gain potential long-term.