When the professionals on Wall Street reach a consensus about whether to buy or sell a stock, it pays to listen more often than not. But in at least one case this year, following the herd of analysts might have resulted in selling Upstart (UPST +3.23%) stock right before it made a major move higher.
Upstart has been swept up in the artificial intelligence (AI) frenzy in 2023, which appears to have caught Wall Street off guard. The majority of analysts tracked by The Wall Street Journal still recommend selling the stock, but here's why they might continue to be wrong.
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Upstart is disrupting traditional lending
For the past 34 years, when a consumer applies for a loan from a bank, their creditworthiness has been measured by Fair Isaac's FICO scoring system. FICO takes into account five key factors, including a potential borrower's repayment history and how much money they still owe to other lenders.
But Upstart says FICO is outdated because its scope is too narrow, and it overlooks too many quality applicants -- particularly those in minority demographics. Upstart uses artificial intelligence (AI) to instead analyze over 1,600 data points on a potential borrower, which includes their employment history, level of education, and even where they live.
According to an internal study, loans originated by Upstart's algorithm result in 53% fewer defaults at the same approval rate as loans assessed the traditional way. Also, Upstart approves a whopping 173% more loans at the same default rate -- this implies banks are rejecting a lot of worthy borrowers.
Plus, since Upstart's technology is powered by AI, it's capable of analyzing data rapidly to make fully automated, instant approval decisions 84% of the time.
Upstart's business model is simple: It doesn't lend any money itself, but rather it originates loans for its bank, credit union, and car dealership partners, and it gets paid a fee for doing so. The upside for the lender is that Upstart's algorithm is faster and more accurate than traditional, human assessment methods, which would take weeks to analyze the same amount of data.
But Upstart is coming off a miserable 18-month period
Upstart was founded in 2012, which means it had operated exclusively in stable economic times up until the pandemic period from 2020 on. Its stock price marched higher until the second half of 2021, when it hit an all-time high of $401, but investors grew concerned when inflation began to spike, ending the period of ultra-low interest rates in the U.S.
That sent ripple effects throughout the economy, with demand for consumer credit plunging. Additionally, all of a sudden, Upstart was struggling to find buyers for the loans it was originating. Institutions adopted a "wait and see" approach when it came to the company's algorithm, because defaults began to climb, and they weren't sure if the loans would continue to perform in line with the modeled outcomes.
Upstart wound up absorbing a number of loans using its own balance sheet, which added credit risk to the company -- something investors did not sign up for -- and sent its stock to a low of $11.93.
Fortunately, as time went on, Upstart released lots of data proving its AI-powered approach is up to the task, no matter the economic environment. As of the first quarter of 2023, the company had a record-high 99 lending partners, which was almost double the number it had a year ago. That signals renewed confidence.
Plus, Upstart recently announced some of those partners pledged $2 billion in new funding to help the company weather any future speed bumps, where it might struggle to find immediate buyers for its loans.
NASDAQ: UPST
Key Data Points
Wall Street might be wrong to recommend selling Upstart stock
The Wall Street Journal tracks 15 analysts covering Upstart stock. Four recommend holding, three are in the underweight (bearish) camp, and the remaining eight have given it the lowest-possible sell rating. Not a single analyst recommends buying. That's little changed from three months ago.
Their average price target is $12.61. But here's the problem: Upstart stock has surged 120% in 2023 so far and currently trades at about $29! That means, had investors listened to Wall Street on this occasion, they would've missed a really nice gain.
Given the challenging economic climate, analysts don't expect loan demand to recover this year. They estimate Upstart's revenue could come in at $548 million for 2023, which would be a 34% drop compared to 2022, though they do expect a return to growth in 2024.
But this is a long-term story, and now that the company is on a more stable footing, this could be a great time for investors to buy in. AI is infiltrating so many industries right now, and it's almost inevitable it will make an impact on lending. For all of its early challenges, Upstart thinks it has a $4 trillion opportunity in the markets for personal loans, automotive loans, business loans, and mortgages.
Since the company is valued at just $2.4 billion today, the risk-reward proposition presented by Upstart stock sure looks attractive, irrespective of Wall Street's opinion.
