Artificial intelligence (AI) is the hottest topic being discussed right now, with investors trying to find ways to bolster their portfolios with businesses that are harnessing the power of this technology. The big tech stocks, like Alphabet and Microsoft, certainly deserve some attention, but so do some under-the-radar names.
Upstart (UPST -2.98%) is one such enterprise. It uses AI to do a better job analyzing credit worthiness compared to the traditional FICO model from Fair Isaac that has been used for decades. Shares are down 42% from their peak, which might be a potential opportunity.
Should investors buy this fintech stock right now?
Upstart's disruptive properties
There are numerous fintech companies that are changing the game in different parts of the broader financial services industry. PayPal dominates the market for electronic payments. Robinhood has revolutionized how retail investors can trade. Lemonade is using data to serve insurance policies directly to consumers. And SoFi Technologies has found a way to make banking more tech-savvy and user-friendly.
But I don't think any business is trying to completely disrupt how prospective borrowers are analyzed and how credit is approved in the way Upstart is. That's why it is such an interesting company. Its AI-driven model looks at 1,600 different factors about a customer, whereas FICO considers just five. Looking at far more variables makes management believe that it can approve more borrowers (while keeping default rates steady) and lower default rates (while keeping approvals steady). It truly is a ground-breaking platform.
That's probably why Upstart continues increasing its partner base, from 50 lending partners a year ago to 99 now (as of March 31). Moreover, the company counts 39 different auto dealerships that use its technology when looking at car buyers. It's a winning relationship for Upstart's partners because they can effectively expand their addressable markets, resulting in more revenue for them while minimizing losses.
Upstart only powers personal loans and auto loans right now. And even then, its 2022 transaction volume of $11.2 billion in these two lending verticals only accounted for a tiny 1% of the total origination value of these markets. That leaves plenty of room for growth in the years ahead.
The leadership team has its sights set on the mortgage market, which has $2.7 trillion of origination value. The business plans to launch a home equity product some time in 2023. Small business loans are another category Upstart wants to be in.
Why I'm staying away
A disruptive company with lots of growth potential could be compelling for some investors. After all, I think that's really what the bullish case centers on. But I'm still not convinced about Upstart just yet.
That's because even though this isn't a bank in the traditional sense, which can be cyclical, Upstart is still completely exposed to the whims of the economy. Business was booming in 2021 when interest rates were low, causing demand for loans to soar. Upstart's revenue and net income skyrocketed that year, only to come under immense pressure in 2022 as the Federal Reserve hiked interest rates at the fastest pace in history.
To be fair, no company is fully immune to the macroeconomic climate -- but in Upstart's case, its success seems to be entirely dependent on factors that are outside of its control. I'm talking about interest rates. That adds an element of risk that should be considered.
The point of having an AI-powered model is that it should get better over time. So if Upstart can prove that its platform can perform well in tougher economic times, while also allowing the business to be profitable on a consistent basis, then the stock is a lot more interesting in my opinion. But by posting a huge net loss of $129 million during the first three months of 2023, it looks like we're still a long way off from that happening.
Therefore, investors should be cautious about Upstart.
