Volatility can mess with your mind. It feels easier to trust a stock that slowly and steadily climbs higher without huge drops along the way than a stock that falls more than 90% and then jumps 170% in a matter of weeks.
Yet that's what is happening with Upstart Holdings (UPST). It rocketed from its $20 initial public offering (IPO) price to more than $400 per share, even as one pundit praised the stock on television but couldn't explain what the company does, and then crashed to $12. And with the help of voracious investor thirst for artificial intelligence (AI) stocks, the AI lender has now nearly tripled from its lows.
Now that you've readjusted your neck from that whiplash, it's time to sort out Upstart's investment prospects. It's OK to be skeptical of a stock that is so volatile, but there are tangible signs that the company can justify its recent hype.
How do banking, AI, and Upstart fit together?
Ironically, despite the vast ocean of data available today about consumers, whether banks lend them money or not still relies on a method that goes back to 1989 when the modern Fair Isaac FICO score was introduced. The FICO score isn't necessarily bad, but it's not perfect. Factors can affect people's score, restricting their access to credit -- even if they're qualified borrowers.
Upstart is challenging the FICO standard with its own offering. It uses AI and proprietary algorithms to analyze data for better lending decisions. It claims it can approve borrowers at the same rate but with 53% fewer defaults. Also, most loan approvals are automated, providing consumers with a faster user experience.
So how does it make money? Most of Upstart's revenue comes from referral fees. The company matches a prospective borrower with a personal loan from a lender that then originates the loan.
In other words, Upstart is sending what it believes to be qualified customers to its partner banks and collecting a finder's fee. It started with personal loans but has steadily expanded into auto loans and has its sights set on more categories.
Upstart tech seemingly works
It makes sense that a new technology such as AI could outperform something created decades ago. But investors must see hard evidence. That seems to be slowly accumulating. Below, you'll see a quarterly analysis that Upstart publishes, illustrating how its software identifies risk in borrowers versus FICO.
As you read from left to right, you'll notice that default-risk grades increase due to Upstart's grading system. Reading from top to bottom, you'll see how default rates increase, but by a lesser degree. Those are default rates based on FICO scores. In other words, FICO is letting some bad apples into the bushel, while Upstart is better at separating them.
Image source: Upstart Holdings.
Morningstar recently published a report about research done by Marco Di Maggio, director of the Harvard fintech lab, that found that Upstart is potentially having success giving credit (and at better interest rates) to borrowers with lower credit scores than what they're finding from traditional lenders. Keep in mind that the research, which agrees with Upstart's published findings, was co-authored by others including an Upstart scientist.
Lenders are supporting Upstart
The less scientific way to judge its platform is by looking at whether lenders want to work with the company. It had 10 bank partners in late 2020 at its IPO and had 99 as of the first quarter of 2023.
Since launching Upstart Auto in late 2021, hundreds of dealerships use its software, and 39 offer Upstart-powered loans. And it has partnerships with nine automakers.
There is a clear trend of more businesses working with Upstart, which only supports the company's claims that its technology works. If it didn't, the word might spread or its network would be losing members at the very least.
A rapid transition from low interest rates to high rates sent Upstart scrambling and has much to do with that whiplash-inducing volatility in the stock. But the long-term outlook seems promising as long as data continues supporting the software's efficacy and lenders continue signing on to work with Upstart.
So far, things look like they're headed in the right direction, which gives investors hope for long-term success.
