Lending technology company Upstart Holdings (UPST 2.72%) has had one of Wall Street's most volatile rides since going public in late 2020. Shares soared more than 1,200% before crashing down in 2022. Today, the stock is trading about 96% off its high, an admittedly tough hole for any stock to climb out of.
What went wrong? Investors (and arguably, Upstart) underestimated the impact of interest rates on its business. Demand for Upstart's loans dried up as interest rates rose, something I previously covered, stunting growth and filling its balance sheet with loans.
Admittedly, it's unlikely that Upstart will revisit its highs anytime soon. However, not all hope is lost. There are at least three green flags for Upstart's future that a long-term investor can build a solid investment thesis around, and here is why the stock could make an eventual comeback happen.
1. Upstart's automotive product is flourishing
Upstart started with personal loans, but automotive loans offer the real opportunity for the company. Upstart acquired Prodigy in 2021 and used its software to launch Auto Retail, a digital vehicle sales and financing platform. The software lets consumers purchase dealer inventory online or in-store and has embedded tools to sign contracts and apply for financing.
The product is still in its early stages of rollout, but the early signs are promising. Upstart reported that borrowers choose its offer 42% of the time when it competes against other funding offers and that borrowers save an average of $5,851 over the lifetime of an auto loan. To date, there are 778 dealerships signed up for Auto Retail, up from 410 a year ago.
Automotive lending is a much bigger market opportunity than personal loans. Management estimates the auto lending market at $780 billion, more than four times the size of personal loans at $162 billion. The size and rapid adoption of dealerships paint a possible scenario where Upstart's auto business one day is better than the personal loan business it built the company on.
2. Upstart's technology is holding its own in a challenging environment
Assuming Upstart's business can't work because its operating performance hit a brick wall is arguably a lazy take. There's no argument that the shift in interest rates devastated Upstart's business, and one could even scrutinize management for not having Upstart more prepared.
At the same time, one should appreciate just how hard things became in lending. Interest rates rose their fastest in a generation last year, and 10-year Treasury bond prices had their worst year on record! Upstart would approve loans with a price in mind to sell them at, and the price loan buyers demanded changed before Upstart could deliver.
Meanwhile, Upstart's data shows its technology is doing a pretty good job amid the chaos. Management publishes quarterly data proclaiming its technology is four times as precise as Fair Isaac's FICO credit scores at identifying risk. Additionally, the company releases data on how the loans it approves perform financially.
Note 1: Upstart internal performance data as of Feb. 7, 2023. The "upside," "baseline," and "downside" percentages are based on Upstart's own internal estimates of the returns observed on each vintage to date. Note 2: Gross annualized return per Upstart internal calculation including an assumption of future cash flows based on most recent performance data. Image source: Upstart Holdings.
Upstart's performance was great when lending markets were loose and it underperformed when they tightened up as rates rose. However, you can see that performance reached a trough in Q3 of 2021 and has steadily improved since then. This is important to monitor, as strong performance could increase buyer appetite for Upstart's loans. There are still risks, but Upstart will take a lot from this challenging time if it survives.
3. Upstart's stock is priced for dead
Sentiment can swing wildly on Wall Street, which went from pricing Upstart like no price was too high to an afterthought. Analysts believe the company will eventually rebound, estimating 2024 earnings per share at $0.86, a price-to-earnings ratio of just 17. Keep in mind this is a young company with an enormous growth runway if it can get through its macroeconomic troubles.
Shareholders could be looking at capturing most of Upstart's long-term earnings growth as investment returns. The company has room for growth in personal and automotive lending and has discussed goals to get into mortgages and small business loans. The stock has a market cap of just over $1 billion, making it a potential multi-bagger if things go well.
Upstart isn't out of the woods yet, and shareholders will learn much about the company's progress over the coming quarters. But with rate hikes seemingly nearing an end, the calming credit markets could set the stage for a remarkable comeback story.
