After a horrific 2022, Upstart (UPST 7.21%) shareholders have had a good run in 2023, as the stock is up around 160%. To many investors, 160% is way more than should ever be expected for a stock in a year, but it looks like it's just the beginning in Upstart's case.
So should you invest in Upstart now? Or is there not much left to run? Let's find out.
The Federal Reserve has hurt Upstart's business
Upstart was an early adapter in using artificial intelligence (AI) in its platform. Its product focuses on assessing creditworthiness and uses alternative measures to analyze a consumer's likeliness to default on loans. By using AI to assess the user, Upstart promises its clients more approved loans with a lower default rate, a win-win for lenders.
Currently, Upstart offers personal and auto loans, of which nearly $1 trillion are originated annually. However, as the Federal Reserve raised rates, the demand for auto and personal loans has deteriorated. This shouldn't surprise anyone, as raising rates is designed to do exactly that.
This action has hurt Upstart tremendously, and Upstart saw its loan transaction volume fall from 465,537 loans totaling $4.5 billion in Q1 2022 to 84,084 loans totaling $997 million in Q1 2023. That dramatic fall caused Upstart's revenue to decrease 67% year over year and drop the company into unprofitability.
So does that mean Upstart is destined to fail? I don't think so.
Upstart's product has been proven to work; just look at the Upstart rating versus FICO credit scores.
Image source: Upstart.
However, because demand isn't there, the company is suffering. Fortunately, auto and personal loans have relatively short time frames on the loan term, so many consumers will need to purchase a new car or start on home improvements within the next couple of years.
This will drive a new demand wave, giving Upstart a much-needed business boost. Plus, if it can break into other sections of the lending market, it will be able to diversify its business away from loans that are more prone to demand cycles.
So with that in mind, just how cheap is the stock today?
The stock trades at a low valuation, even though investors know the business is down
At its peak in 2021, Upstart grew its revenue by more than 1,000% and earned a valuation of nearly 50 times sales. Once that growth rate tumbled back down to earth, its valuation followed.
Now, Upstart trades at a lowly 4 times sales.
UPST PS Ratio data by YCharts
If Upstart can regain even a 10% profit margin (it was 16% at its peak), that would value Upstart at 40 times earnings if it could flip the profitability switch. However, for Upstart to do that, it would need to substantially increase its revenue, which would drop the price-to-sales ratio significantly.
So in all reality, should Upstart's business increase to the point where the company can become profitable again, the stock would look even cheaper.
To me, Upstart seems like a no-brainer investment. We have proof that the product works, but that demand isn't there right now. When the tide flips, Upstart will see strong demand and push the stock back up to normal levels.
However, this turnaround may take a few years and isn't guaranteed. That means Upstart shouldn't make up a large part of a portfolio -- maybe 1% to 2% at most. That way, if it fails, it's not a massive loss. But if the investment succeeds, it could become a portfolio-defining investment over the next three to five years.
