Upstart Holdings (UPST 0.96%) has gone from darling to dud in a short time span. Things look worse than ever after the fintech company missed Wall Street's expectations for third-quarter revenue and income and offered weak guidance for the fourth quarter.
There are two parts to this story. One is the company's own struggles, and the other is the economic climate. Without the second part changing, it doesn't seem like Upstart can get back to growth. What should investors expect in one year from now?
Why Upstart is struggling
Upstart is a credit evaluation platform that uses artificial intelligence to make more accurate assessments than traditional credit scoring tools. It offered compelling evidence of this when it first became a public company almost two years ago, and it says that loans using its technology result in 75% fewer defaults at the same approval rates. As a result of its better evaluation system, it has been able to approve more loans at a lower risk to lenders. That attracted more credit partners, higher revenue, and increased profits.
However, in light of rising interest rates, its outlook has changed dramatically. Lenders are more reluctant to approve loans as the potential for defaults increases, drying up sources of funding and fees for Upstart. Although Upstart insists its system still works better even in this environment, banks are more reluctant to take extra risk.
Upstart revenue dropped 31% over last year in the third quarter to $157 million, and it posted its second consecutive quarterly loss, at $56 million. Loan originations decreased 48% in the quarter. But in addition to the risk-averse lending partners, loan applications were down in the quarter as well; borrowers are balking at the higher interest rates. And because Upstart relies on a machine learning model that uses historical data points to inform its technology, the algorithm is coming up with higher interest rates consistent with the economic environment. All of this is leading to a slowing business.
It's worth noting that at the same time, traditional credit scoring company Fair Isaac Corp. posted an increase in revenue and a healthy rise in earnings per share. Just as investors flock to safe stocks in a turbulent market, banks are also turning to scoring methods like FICO that have proven themselves historically amid interest rate fluctuations.
The light at the end of the tunnel is very weak
So is Upstart's model actually better? And if so, why isn't it more resilient?
Upstart's model might be better, but it's still improving. And despite the addition of new partner banks, it's still extremely small compared to the FICO model. Over time, Upstart may demonstrate its value. But in the short term, as interest rates continue to rise and the economy remains pressured, Upstart is likely to continue struggling.
Signs still point to strong potential. For example, it is steadily adding banking and auto partners. It added 12 new banking partners in the third quarter for a total of 83, and it added 62 auto dealer rooftops for a total of 702. It has a huge addressable market of over $5 trillion, with plans to enter new markets over the next few years.
Will Upstart end up being a cyclical company that does well when the economy does? Can it improve to the point of remaining stable and resilient, like FICO? Since we don't have the answers to these questions, Upstart looks risky right now.
In 1 year, things may be no different
Interest rates are still rising, and stocks are still falling. Management already gave a weak fourth-quarter outlook, and Upstart's near-term prospects don't look so hot.
As a result, Upstart stock is now down more than 90% over the past year. At this price, it trades at the low multiple of 1.9 times sales. That looks compellingly cheap for a stock with high growth potential.
There doesn't seem to be any rush to buy the stock, since it's not likely that conditions will materially improve over the next year. Keep it on your watch list, though, as an improved economy may give this company a chance to shine.
