What happened

Upstart Holdings (UPST 46.02%) stock rallied in June, with shares surging 31.5%, according to data provided by S&P Global Market Intelligence. That's nearly 5 times the 6.5% gains of the S&P 500 (^GSPC 0.38%), compounding its impressive climb so far in 2023, with the stock up an eye-popping 189%.

The company has benefited from multiple factors, including its ties to artificial intelligence (AI), overall improvements in the economy, and a rebound among technology stocks. Prevailing economic conditions aside, the fintech specialist got a massive vote of confidence from a well-capitalized investor. This development has served to ease investor concerns regarding the viability of its loan portfolio.

So what

Upstart's stock continued to climb in June, but the catalyst that sparked its ascent began earlier. A little background will help provide context for the move higher.

The company bypasses traditional credit scores, using sophisticated AI algorithms to better determine which consumers are more likely to repay their loans. By expanding the pool of potential loan recipients, Upstart has carved out a niche for itself with lenders looking to expand their base of borrowers.

The challenging economy wreaked havoc on Upstart's business as bank partners were reluctant to fund new loans based on Upstart's novel process, fearing a commensurate increase in loan defaults. Upstart could only support so many loans on its own before a growing pile of loan debt weighed on its balance sheet.

When the company reported its financial results in early May, CEO Dave Girouard said it had "secured multiple long-term funding agreements together expected to deliver more than $2 billion to the Upstart platform over the next 12 months."

Then, just days later, alternative investment manager Castlelake announced that it had agreed to purchase up to $4 billion in consumer-installment loans from Upstart. The company would acquire existing loans on Upstart's books and purchase additional loans as they were funded. This partnership clears the backlog of loans on Upstart's balance sheet while providing a market for newly approved loans. 

Now What

As a result of these developments, Upstart got a little love from Wall Street. BTIG analyst Lance Jessurun initiated coverage of Upstart with a buy rating and assigned a $42 price target. At the time, that represented potential gains for investors of nearly 25%. The analyst cited the partnership with Castlelake and Upstart's efforts to keep loans off its balance sheet as factors that put the fintech company on "a path back to growth and profitability." 

To be clear, Upstart still has work to do. Many investors are still watching to see how Upstart performs through an entire credit cycle before sounding the all-clear. Upstart has identified more than 1,600 variables that it uses to determine credit risk, and only time will tell if its formula consistently outperforms traditional credit scores.

Upstart's dramatic move higher so far this year has resulted in a commensurate increase in its valuation. The stock sells for 38 times forward earnings and 4 times next year's sales, so it won't appeal to everyone. 

However, if the company's novel approach to lending takes hold, it could usher in a veritable tidal wave of new consumer loans. If that happens -- and I certainly believe it could -- Upstart could prove to be a bargain at this price.