After a fantastic rise and a tremendous fall, Upstart Holdings (UPST +6.85%) is now a humbled company trying to make it in a harsh operating climate.
It continues to capture investors' attention because its risk-reward proposition is intense. The company provides services that could potentially be revolutionary in the financial industry, and it could quickly grow. Investing now, when the stock is cheap, could lead to incredible gains. At the same time, Upstart could end up being a flop, and the stock could go nowhere.
Let's consider where we can expect it to be a year from now.
Well, it depends on the economy
Upstart operates an artificial intelligence-based platform that lenders can use to evaluate would-be borrowers' credit risk. Management says it approves 173% more loans than banks using traditional FICO scores at the same default rates, which is an incredible benefit. It's easy to see why its sales were soaring.
However, that's changed since the Federal Reserve began rapidly raising benchmark interest rates last year. Upstart had been demonstrating stellar growth, but now, its sales are declining, and its profits have turned into losses. In 2023's first quarter, revenue tumbled a whopping 67% year over year to $103 million, and its net loss was $129 million.
Upstart stock has plummeted 91% from the high point it touched at the end of 2021.
The company was hit hard by rising interest rates and a slowdown in economic growth. In this type of macroeconomic environment, default rates on loans rise, and it's harder for Upstart's platform to identify low-risk borrowers. That makes it harder to get loans approved, and also more difficult to get competitive rates for borrowers, who therefore may not be able to get loans that work for them. Upstart originated about $1 billion in loans in Q1 2023, down from more than $4 billion in the prior-year period.
It's certainly challenging to provide competitive lending services in this environment. But as a young and small company that had only operated in good times, Upstart wasn't prepared for where the economy is today. If the economy is stronger a year from now, Upstart will benefit.
It may be starting to improve
Although its woes were precipitated by macroeconomic forces, and it will continue to face those challenges until conditions become more favorable, management assured investors that it's not sitting idly by and waiting for that to happen.
One important move it made was to implement a cost-cutting plan. Upstart laid off 30% of its workforce, and is also reducing its technical infrastructure in ways that should save it up to $10 million annually.
Next, through several major deals, it secured long-term funding agreements worth $2 billion over the next year. This is the other side of its process, since it sells the loans it approves to institutional lenders. This update was cheered by investors, and it bodes well for Upstart's long-term viability.
Upstart's machine learning model is now training on millions of data points from a challenging environment unlike those it had previously been tested in. This will make its model that much stronger, and the company should emerge from this period with an even better-performing product.
Chief Financial Officer Sanjay Datta said that Upstart was anticipating "a return to sequential growth and cash profitability in the current market environment," and said that management felt that the company has "weathered the worst of it."
The market is wide open
Upstart hasn't entered all of its potential lending markets, but it is entering the mortgage sector later this year. This will be its biggest market opportunity, with $2.7 trillion in mortgages originated annually. It's also still adding partners for both its personal loan and auto loan products.
A year from now, Upstart's total loan originations might still be below its 2022 numbers, but it should have more client partners on the platform for all of its products.
The stock is cheap, but the risks are high
Here's where it gets sticky. Upstart's share price is now up a stunning 145% in 2023. That's a display of a lot of investor confidence for a company that has yet to demonstrate that its business is rebounding. What you don't want is to get involved in another scenario where investors chase an exciting stock and run the price up to unsustainable levels. At its peak, Upstart stock was trading at the absurd valuation of 465 times trailing 12-month earnings.
Currently, the company has no price-to-earnings ratio because it's posting net losses, but it does trade at a price-to-sales ratio of about 4. That's reasonable for where Upstart is right now.
In a year, Upstart's sales are likely to be heading higher again, even if the economy is still volatile, because the market may have bottomed out. And management is taking action to make the company more efficient.
In a case like this, risk-tolerant investors who have time to wait might want to open a small position. But even if that description applies to you, only invest in Upstart what you can comfortably afford to lose.
