Upstart (UPST 0.83%) recently announced its 2023 first-quarter financials, and investors were impressed. Revenue of $103 million and adjusted loss per share of $0.47 were better than analysts had hoped. And since that financial update, the stock is up more than 70% (as of May 19).
With the recent positive news, should investors seriously consider buying this disruptive fintech stock now to ride the strong momentum, even though it's still well below its all-time high? A closer look at the bear and bull cases for the company might provide more clarity.
Upstart's bear arguments
I think one of the most obvious bear arguments against Upstart is that its business is extremely sensitive to the macroeconomic environment. While the company prides itself on being a platform that connects its banking partners with borrowers, it's hard to understate how desperately Upstart needs things outside of its control to work to its benefit.
In 2022, for example, when the Fed aggressively hiked interest rates and demand from borrowers softened, Upstart's revenue declined 1% year over year. And total loan volume fell meaningfully. Factors outside of the company's control dictate its prospects -- not a good characteristic.
Being overly sensitive to macro factors is even more painful when the business isn't consistently profitable. Yes, Upstart posted positive net income of $135 million in 2021, but that was when interest rates were lower and credit markets were more favorable. Last year, the business posted a net loss of $109 million. And in the first quarter of 2023, Upstart's net loss ballooned to $129 million. It's hard to know when this will change for the better.
Investors might also shy away from owning this stock because of the growing value of loans held on the balance sheet. As of March 31, Upstart's nearly $1 billion loan balance was far greater than $600 million a year ago. As credit markets have dried up, Upstart hasn't been able to sell these loans to third-party investors.
To its benefit, the company did announce on its earnings call that it had secured $2 billion worth of committed funding from investors to purchase loans -- a positive sign. A subsequent $4 billion commitment from private lending company CastleLake also bolstered sentiment. But unless the loan balance it has on the books decreases going forward, it's hard to ignore the added credit risk this business faces if borrowers suddenly start to default at higher rates.
Upstart's bull arguments
Compared to the traditional Fair Isaac FICO model, Upstart's AI-powered lending platform, which analyzes over 1,000 variables, promises to better assess credit risk. The result is greater access to borrowers who might be turned down using regular methods. And for banks, this expands the addressable market, leading to greater revenue potential.
Upstart claims its technology can increase approval rates while leaving defaults steady. And the platform can also lower defaults while keeping approval rates the same. This is a great outcome that should get better over time as more data is analyzed. And lenders are interested in this offering, as Upstart now has 99 lending partners, up from 50 a year ago.
Upstart's current products (personal loans and auto loans) combined create an annual market opportunity of $950 billion. That's sizable, to be sure, but it's tiny compared to what's on deck. "I'm also pleased to let you know that we expect to launch a home equity product later this year," CEO Dave Girouard said on the Q1 2023 earnings call. This could be the first step to fully enter the mortgage market, which has annual originations close to $3 trillion. The opportunity is huge for Upstart. Even if it chips away and commands a small fraction of the market for home loans, the company's revenue is poised to climb higher over time.
Upstart's entire business model was created with AI in mind, well before it became a popular buzzword. And investors can buy shares in this innovative company at a steep discount of 94% to its all-time high. While Upstart's stock is up a notable 83% in 2023, it only trades at a price-to-sales multiple of 3.2 today, which is historically cheap.
Despite its undeniable potential to continue disrupting a massive industry with its AI model, I'm not rushing to jump on the Upstart bandwagon just yet. The business still has a lot to prove, the most important being its ability to generate profits in all economic environments.
