October 2021 and November 2021 were great times to be an investor in SoFi Technologies (SOFI 3.69%) and Upstart (UPST 2.76%). The latter's shares reached all-time highs, while the former's stock price had largely recovered from a post-SPAC (special purpose acquisition company) sell-off and seemed primed to surge higher.
The past 18 months and change haven't gone nearly as well. SoFi shares are down 78% as of this writing, while Upstart's stock is off 93%, joining the rest of the SPAC/growth/software-as-a-service (SaaS) stock sell-off that's wiped out billions of dollars in investor wealth.
Yet there are signs of life: SoFi shares are up 14% so far this year, while Upstart stock has doubled since the beginning of May.
But investors still have reasons to be concerned. Neither company is profitable at present, and concerns about the economy casts a pall over their near-term prospects. The good news, however, is that they have the funds to keep moving forward without needing to tap the capital markets, and they're both on the cusp of doing amazing -- and very profitable -- things.
I don't think it's too much of a stretch to see a future where, if a few key things go right, they both could become nearly unstoppable. And that could make both stocks huge winners. Here's what needs to go right.
Upstart: Prove to lenders it can lend more profitably
Upstart has built a pretty impressive lending platform, using artificial intelligence (AI) to better measure -- in its opinion and increasingly in the data -- credit risk. For lenders, this could be a gold mine. For people who've been viewed as less creditworthy, it could be a major step toward wealth equality.
The problem for Upstart? Its lending partners have drastically pulled back from originating loans on its platform.
Revenue was down 67% in the first quarter, and the company lost $129 million -- a bigger loss than its $103 million in revenue. It did generate a $67.6 million contribution profit, indicating its core business remains high-margin. But the massive drop in activity has gutted its bottom line, even after multiple staffing cuts to lower expenses over the past year.
The one thing that has to continue going right for Upstart to reach unstoppable status is accuracy in its lending models. The company says lenders can significantly reduce the number of loans they currently issue on which borrowers default or issue far more loans at similar default rates as they currently see.
In other words, Upstart says lending partners can either prioritize credit quality or loan volume and achieve the desired outcome while better managing risk. For a lender, this is the holy grail: more predictable, profitable, lower-risk loans.
So far, the data indicates that Upstart's AI-powered underwriting model is as good as or even better than advertised. Over the past year, it's doubled its partner count. But these partners want more proof that the platform will keep identifying the safest borrowers more accurately than the status quo. If Upstart's models continue to deliver as promised, lenders will flock to its platform, unlocking its cash engine in ways we just started to see in 2021.
SoFi: Thread the needle of growth and risk
For most people, the banking crisis of 2023 came out of nowhere, which by and large is typical of bank cycles. About once a decade, we go through some sort of a crisis and a few banks fail. In the 12-plus years since the global financial crisis, many of us have forgotten that the most important principle in banking is confidence. If depositors don't trust a bank, it will fail. Now that it's a bank, SoFi must navigate these waters well to succeed.
So far, SoFi seems to be doing a solid job on the growth front. It added almost 1.8 million net new customers over the past year, with many of those customers signing up for more than one financial product. Members signed up for almost 2.7 million net new products.
A lot of those customers came over because of SoFi's high-yield offerings for deposits. This was a big reason SoFi's cost of funding was 2.6% in the fourth quarter of 2022, compared to 0.73% for Bank of America in the same period.
SoFi can afford to attract customers with those high yields because it's building a lending business that's predominantly personal loans and credit cards. It's only just beginning to get its feet wet with lower-yield lending lines. As a result, its net interest margin is more than double that of legacy banks like BofA.
But this comes with a risk: Credit cards and personal loans are unsecured debt, so they're often the first thing people delay paying or even default on when times are tough. There's no asset that SoFi can repossess if someone stops paying.
This hasn't been an issue so far, but it could be a significant risk during a recession if SoFi hasn't done a good job managing credit risk. If it has, its future path to profitability could prove unstoppable.
Getting to the other side
Between the two, SoFi's management has a lot more control over its future. It has built a solid -- if slightly expensive -- customer acquisition machine, via marketing and its high-yield bank accounts. As long as the loans it funds with those deposits continue to prove high-quality and low-risk and it keeps those depositors happy by adding other financial services products, SoFi could prove to be America's next big banking success story.
Upstart has less control over its future. It's gone from 10 lending partners at its initial public offering (IPO) and 50 just one year ago to 99 at the end of the first quarter. But revenue has crashed over the past year as those lenders have paused and pulled back from personal loans.
That cycle will turn at some point. If Upstart's lending model still proves accurate and more profitable, all those new partners will flood the platform with borrowers and fill Upstart's coffers with cash.
In both cases, there's reason to be cautious, but if they get the things above right, unstoppable status -- and big gains for investors -- could be in their future.
