If you're an investor just learning about Upstart (UPST 0.79%) now, consider yourself lucky. The fintech stock soared to unimaginable heights shortly after its stock market debut in late 2020. After reaching a peak in 2021, though, the shares of the online lending platform quickly collapsed and it's currently trading at around 95% below its former peak.
It could take another lifetime before Upstart passes its former high-water mark but investors who buy the stock at its depressed price could realize market-beating gains over the next several years.
How Upstart could outperform
The traditional benchmarks lenders use to evaluate individual credit risk, such as FICO scores, weed out a lot of creditworthy borrowers. With help from proprietary artificial intelligence (AI) technology, Upstart's lending platform finds heaps of borrowers who would have slipped through the cracks.
Back in 2021, lenders used Upstart to originate 1.3 million loans, which was a fourfold increase compared to 2020. Unfortunately, rapidly rising interest rates coupled with fear of a recession means far fewer lenders are looking for non-traditional borrowers. This is why Upstart's partners originated 62% fewer loans in the fourth quarter of 2022 than they did a year earlier.
Upstart has been looking for new sources of capital to provide more reliable and persistent funding. Investors are justifiably nervous about the company altering its previously successful hands-off approach but keeping more loans on its own books probably isn't as dangerous as it may seem. Loan vintages from 13 of the past 19 quarters are expected to deliver a gross return of 8% or better.
Shares of Upstart aren't at their all-time low but they could turn out to be a tremendous bargain if business picks up again. Right now the stock is trading at around 10.6 times 2021 earnings.
Why Upstart probably isn't the best stock to buy right now
I'm going to go out on a limb here and suggest that the ability to evaluate individual credit risk beyond the scope of FICO isn't a very big deal anymore. I say this because instead of hiring Upstart, Sofi Technologies is running heaps of social security numbers from potential borrowers through its own algorithm.
| Company | Total Value of Loans Originated in Q4 2022 | Change (YOY) |
|---|---|---|
| Upstart | $1.5 billion | (62%) |
| SoFi | $3.0 billion |
(21%) |
Data sources: Upstart and SoFi Technologies. YOY = year over year.
While demand for Upstart-originated loans fell off a cliff in the fourth quarter of 2022, SoFi fell by just one-fifth. In terms of total loans, SoFi actually reported a 24.2% year-over-year gain in the number of active loans.
For now, SoFi is the only bank I know of with millions of depositors that avoids Upstart in favor of its own AI-powered credit risk evaluation tool. Investors want to keep an eye open for default rates on recently originated loans from both Upstart and SoFi. If SoFi doesn't collapse under the weight of defaults you can bet that Upstart's largest partners will notice and start looking for ways to run their own credit risk evaluations.
Time to watch
If the Federal Reserve quits hiking interest rates and Upstart's existing lending partners go back to business as usual this stock could soar. Unfortunately, economic indicators that keep sounding alarms on Wall Street suggest Upstart's problems are just beginning.
While Upstart might be able to find less fickle lending partners, they will more than likely want a large slice of any potential profits. I own some shares of Upstart but I won't even think about adding more until the company's operation returns to profitability.
