Few companies personify the boom and bust of the pandemic investing era more than Upstart (UPST -2.62%). After going public in late 2020 at around $30 per share, Upstart found itself trading at nearly $400 per share in late 2021. Anyone who rode the train up and got out before it fell off a cliff made an impressive return -- but if you've held on until today, you're just breaking even.
With the stock around $30 today, it's been a pretty flat investment for those who bought and held shares for two years. However, Upstart has grown significantly since then, so does that make the stock a buy now ? Or is Upstart an undesirable holding now that it has burned many investors? Let's take a look.
Low interest rates fueled Upstart's growth
One factor can sum up why Upstart's stock did so well in 2021: low interest rates. Upstart's products utilize alternative methods to judge creditworthiness, avoiding the traditional FICO score. It promises lenders fewer defaults with the same approval rate, which is a win for the company's customer base. To do this, it utilizes AI (artificial intelligence) to analyze consumers and look into factors a FICO score may ignore.
With dirt-cheap loans readily available, as the Federal Funds Rate was essentially 0%, banks were trying to make loans to as many consumers as possible to boost interest income with volume. By turning to Upstart, lenders could offer loans with more generous terms to borrowers than they'd be able to using a traditional FICO score.
Even though consumers have come under pressure since then, Upstart's promise of a better judgment of creditworthiness has remained true.
Image source: Upstart.
Even customers with poor FICO scores (below 639) but robust Upstart ratings (A+) have maintained a relatively low default rate of 4.7%
So it's clear that Upstart's product still works; however, with higher interest rates, fewer consumers are seeking personal loans. This caused Upstart's volume to crumble, as it only processed $997 million in loans during the first quarter, down from $4.5 billion in Q1 last year.
Understandably, this decline in activity caused Upstart's revenue to tumble 67% year over year, and caused it to lose $129 million, versus 2022's $33 million profit.
Clearly, business isn't going well for Upstart thanks to the current interest-rate environment. But does that mean investors should avoid the stock?
The stock trades as if it will never recover its loan volume
Looking at the valuation of Upstart's stock, it's in the basement, especially compared to its prior valuation. And Upstart will likely never see the 30 times sales valuation it reached in 2021 (nor should it).
UPST PS Ratio data by YCharts
Still, this cheap level shows investors have run out of patience with Upstart, and moved on to look for better offerings. This sentiment could be a buying opportunity, as the company's technology works well and is still attracting clients.
Castlelake, an alternative investment manager, recently agreed to purchase up to $4 billion in consumer loans from Upstart. This would be a massive boost for Upstart, as it desperately needs higher loan volume. Additionally, the company announced that Mercedes-Benz will roll out Upstart's lending model to all dealerships in the U.S.
However, Upstart will likely struggle until loan demand picks up in the U.S., which will only occur after the Federal Reserve cuts interest rates or all of the loans utilizing the cheap money lent during COVID are paid back. When that happens, Upstart should see a demand surge.
By buying the stock now, you can get ahead of that business spike -- but it may be years before it happens. As a result, I think Upstart makes a good buy as a small percentage of your portfolio, but only if investors forget about it for five years.
Upstart's story will take a while to play out, but giving up on it now doesn't seem like a wise strategy.
