Upstart (UPST 0.79%) stock has had one of the most spectacular downfalls in recent market history, going from hot to not in a relatively short time frame. It has lost 85% of its value over the past year, and with continued global economic pressure, that's unlikely to change in the near future.
But what will happen when the economy improves? Let's see what Upstart could look like in five years' time, and how that might affect your decision to invest -- or not.
Off to a great start
Upstart's mission is to make credit more accessible to all kinds of people, particularly those who have been denied it in the past despite indications they don't pose a high risk of default. It claims that only 48% of Americans have access to prime credit, even though 80% of Americans have never defaulted on a loan.
It has been able to accurately identify real credit risk through its artificial intelligence-powered platform, which evaluates many more criteria than traditional credit scoring systems. According to Upstart, its platform has 53% fewer defaults at the same approval rates as traditional lenders, and it gives borrowers 43% lower rates.
It's easy to see how this could be revolutionary for the lending system, and why the company posted such incredible growth throughout its first year as a public company.
How the economy impacts Upstart
Unfortunately for Upstart investors, those good times came to an abrupt halt in 2022. When the Federal Reserve raises interest rates as it had during the past year, that trickles down to lending institutions throughout the U.S. There are several major consequence from this that relate to Upstart's business. As interest rates rise, default risk increases because it's harder to pay back loans at higher interest rates. That skews the approval algorithm, and Upstart's platform will approve fewer loans.
Next, fewer people are looking for loans at higher rates. When it's cheap to borrow, more people do it. When it becomes more expensive to borrow, people cut borrowing.
Finally, in this inflationary environment, everything costs more, and people reduce all kinds of spending. That's more significant in less affluent communities where every penny counts, and those are the communities that Upstart's model is meant to target and help.
Why that could be a good thing
The flip side is that in a good economy, with low inflation and interest rates, Upstart has thrived. The likelihood is Upstart will be able rebound when good times return.
Consider Upstart's growth and profit rates from last year into this year.
| Metric (YoY) | Q3 22 | Q2 22 | Q1 22 | Q4 21 | Q3 21 | Q2 21 | Q1 21 |
|---|---|---|---|---|---|---|---|
| Sales growth | (31)% | 18% | 156% | 252% | 250% | 1,018% | 90% |
| Income growth | (293)% | (180)% | 323% | 589% | 300% | 700% | 573% |
Data source: Upstart quarterly reports. YoY=year over year.
Upstart's performance mirrors that of the economy, like many cyclical stocks and financial stocks. However, many banks continue to post strong performance, while Upstart's revenue has plummeted. That could be due to it still being a young company. It's still building its business, having gone from 31 credit partners at the end of the 2021 third quarter to 83 at the end of the 2022 third quarter.
Also, as an AI-driven company, its model should improve, and become more valuable, as it adds data points. In five years, with an improved economy, lower interest rates, and more lending, Upstart could make a huge comeback. Even a year from now, if interest rates decline, the company should begin to see its fortunes reverse.
The long-term outlook looks compelling
Beyond that, Upstart is just getting started in terms of its market opportunity. It started out with personal lending, but it has successfully branched into auto loans. Auto dealership rooftops soared from 291 at the end of the 2021 third quarter to 702 at the end of the 2022 third quarter.
It sees a total addressable market of $5 trillion as it enters small business loans and mortgages, which itself would be its largest market opportunity at $3.8 trillion. Management has said it hopes to enter mortgage lending in 2023.
But today that comes with a healthy dose of risk
It truly seems like Upstart has incredible potential to create shareholder wealth. At the same time, it fell into this mess because it's not time tested, and it hasn't been able to continue posting strong results under pressure. That means it's quite risky, because there's no way to know if it will be able to demonstrate value in the future.
For now, it only remains a buy for risk-tolerant investors -- but others should keep it on their watch lists.
