Artificial intelligence lending company Upstart (UPST -1.25%) surged after releasing first-quarter earnings. It's a nice change of pace for investors who have watched the stock steadily plod lower, falling 95% from its highs.
The company entered earnings with substantial short interest in its stock, which could have much to do with its post-earnings pop. In other words, you might have missed out if short squeezes are your game.
However, long-term investors could have a compelling opportunity to add shares while the company's fundamentals are still turning over. Here are some very promising signs that Upstart could eventually thrive again.
Continued signs of fundamental progress
Instead of a traditional credit score, Upstart uses artificial intelligence to determine consumer creditworthiness. It claims that its algorithms analyze risk better, leading to better outcomes for banks and consumers alike, especially disadvantaged individuals banks might overlook.
But Upstart is a new tool in an industry with very established traditions. Upstart has the burden of proving its technology works and convincing debt markets to purchase the loans it approves. In a much tighter credit market with rising rates, Upstart has been stuck holding loans on its balance sheet, a significant factor in the stock's collapse.
Image source: Upstart Holdings.
I've maintained for a while that Upstart's long-term prospects are salvageable if the company can continue expanding its network of partner lenders and demonstrate that its AI successfully identifies risk. It looks like Upstart made more progress in Q1. The lending partner count grew to 99 from 50 a year ago. Additionally, its credit-grading system continues filtering out risky borrowers more effectively.
A potential gamechanger announced
Upstart's growth collapsed when loan buyers stopped picking up the loans it was bringing to market. The solution was to acquire buying partners that would commit funding so that Upstart could approve a loan knowing it had a buyer lined up. Management noted that it was in discussions with potential partners last quarter, so it was a huge positive when Upstart announced it had acquired $2 billion in committed funding.
It's a small step; considering loan volume in Q1 of 2022 was $4.5 billion, $2 billion is a drop in the bucket. But this shows that Upstart can get funding and is progressing. Investors should hope that Upstart continues adding funding sources in future quarters. Doing so could go a long way in stabilizing Upstart's business through the ups and downs of the credit market.
To build on that, Upstart also managed to decrease the loans held on its books. Another small step, as loans declined from around $1 billion to $987 million. Upstart isn't out of the woods, but progress is progress, and it all starts somewhere. Now it's about improving on this in future quarters.
Is Upstart a buy?
Upstart's business fundamentals have imploded over the past year, making it tricky to value the stock. Analysts believe earnings per share (EPS) will come in at negative $1.15 this year, so you can't even use profits. But analysts also believe the business will return to profitability in 2024, calling for EPS of $0.81, a price-to-earnings ratio (P/E) of 17 against that estimate.
The business processed 80% fewer loans in Q1 than in the prior year, so there is a chance earnings growth could aggressively ramp up as Upstart gets back on its feet. If you're looking for a quick profit, Upstart is more of a gamble than an investment today. The company still grapples with a harsh operating environment, despite signs of progress.
But Upstart could also soar to new heights if it can stabilize its business with more committed loan funding, keep adding lending partners, and survive what has been an interest-rate roller-coaster ride. If the worst is indeed over, the future looks bright.
