Investors in Upstart (UPST -0.78%) have -- to put it lightly -- experienced a bit of volatility since the company went public in late 2020. At one point in 2021, the shares were up over 1,000% in less than a year before falling more than 95% from all-time highs in 2022. Now, the artificial intelligence (AI) lending platform has been resurrected, likely due to investor excitement around recent AI innovations from companies like OpenAI.
The shares are up around 140% in the past 30 days, and the question is whether a true turnaround in Upstart stock is finally in order.
Data source: YCharts.
Why is the stock up? AI, of course
Upstart pitches itself as an AI-focused loan platform that goes beyond traditional credit scores. Using modern tools, machine learning, and other innovations, it is able to seamlessly offer credit solutions to individuals, with a focus on personal and automotive loans at the moment. It directly lends to consumers but also works with other financial institutions to power their loan underwriting operations, earning fees on every loan originated through its platform. Typically, Upstart will take these loans and sell them to third-party investors, which removes the credit risk from its balance sheet (more on this later).
Seeing as Upstart has AI marketing plastered across its investor materials, it is no surprise to see the stock soaring along with other AI beneficiaries like Nvidia and Microsoft.
There is also the curious case of Upstart's short interest. Short sellers borrow shares, sell them and hope to buy them back if the shares fall and pocket the difference for a profit. The short interest estimates the percentage of Upstart's shares outstanding that have been loaned to these short sellers, quantifying how heavily they're betting against the company. As of this writing, third parties estimate that Upstart's short interest is as high as 35% of the shares available for public trading, making it one of the most heavily shorted stocks out there. Stocks with high short interest can be extremely volatile -- both up and down. When a heavily shorted stock starts rising, short sellers come under pressure to buy back the shares loaned to them, which can further drive up the share price in what is called a short squeeze. It is possible this is what happened to Upstart stock over the past month amid the AI froth.
The business fundamentals look weak
The narrative has changed around Upstart this year because of AI, but what will really matter over the long term is how much it generates in profits for shareholders. Today, its financial trajectory looks bleak.
Last quarter, Upstart's revenue fell 67% from a year earlier to $103 million, driven by a decline in loan volumes of 78% year over year. This has led to a reversal of profitability, with net income going from as much as $150 million over a trailing-12-month period to negative $270 million over the past 12 months. With less than $500 million in liquidity on its balance sheet, Upstart may be forced to raise money from the capital markets if these losses continue to pile up. It also doesn't reflect well on how confident its lending partners are in the AI platform.
What's more, Upstart has been forced to keep loans on its balance sheet as demand from institutional loan investors has waned. At the end of last quarter, it held just under $1 billion in loans outstanding compared to less than $100 million in the first few quarters after it went public. Why has Upstart struggled to offload its loans? Because these loans underperformed their return projections, starting in early 2021. New loans in recent quarters have gotten closer to projected returns, but it is clear that investors are less willing to take on Upstart loans at the moment. This is not good for shareholders as Upstart now has major credit risk on its balance sheet.
Data source: YCharts.
Is the stock cheap?
It is difficult to value Upstart stock. For one, the business is unprofitable. And two, it is unclear how much annual revenue the company will generate, even next year.
Regardless, let's try to make some estimates and ballpark what Upstart could earn in the future. First, let's assume the company can start increasing loan volumes again and achieve $1 billion in annual revenue within a few years, which is not far off from what it generated in 2021. With high gross margins, let's also assume it can reach 20% net profit margins. That would equate to $200 million in net income, giving the stock a forward price-to-earnings ratio (P/E) of 14.
These are some optimistic assumptions. However, if you believe Upstart's AI lending will continue to grow, the stock will likely do well over the long term if you buy right now. Just make sure to size the position rationally.
