Artificial intelligence (AI) stocks are hot these days and few have been hotter than Upstart (UPST 2.76%), the AI-based consumer lending company. Like other AI stocks, Upstart has been on fire this year and through July. The stock basically doubled last month. Upstart trounced the S&P 500, which only made modest gains in July.
What was particularly noteworthy about the stock's gains last month is that they came on virtually no news about the company. Instead, the stock seemed to gain mostly on more economic data showing inflation is coming down and several other indicators are rebounding as more investors are becoming convinced that this is the start of a new bull market.
What Upstart does and where it stands at the moment
For those unfamiliar with the company, Upstart uses machine learning to power algorithms that screen loan applicants for creditworthiness using an extensive list of evaluation criteria. It then determines if an applicant qualifies, offers the information to a partnering bank that issues the loan, and earns a fee for the service. The company claims that its technology is significantly better at evaluating applicants than Fair Isaac's FICO credit score, the tool that's typically used by the banking establishment. Upstart also makes money originating and servicing consumer and auto loans itself short-term before selling off the loan to a bank.
Upstart, which went public in December 2020, soared through 2021 as revenue skyrocketed in a low interest rate environment and on soaring demand for its loans. However, in 2022 that momentum reversed as interest rates rose, credit standards tightened, revenue fell, and the stock crashed, falling as much as 97% from peak to trough.
As already noted, the stock recovery in 2023 has come in part from the heightened interest in all things AI. The other major factor driving Upstart stock higher was an ongoing short squeeze in the stock. Upstart remains a popular short bet in the market, meaning many investors are betting on the stock to fall. As of mid-July, 36% of the float was sold short, but those investors have been squeezed time and again as the stock price more than quadrupled this year. During July, the stock jumped several times on higher-than-normal trading volume, an indicator that a short squeeze was sending the stock higher.
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What August will bring for Upstart
Upstart will face a major test on Aug. 8 when the company reports second-quarter earnings.
Investors cheered its first-quarter earnings report in May as the company's guidance called for sequential revenue growth, a sign that the worst of the economic slowdown seems to be behind it. That sparked a rally that has carried the stock up more than 300% since then.
Now, Upstart seems to be at a pivotal moment. The stock is rallying again as if the business is set for a rebound, but year-over-year comparisons show that the business is still down substantially. Upstart's own guidance called for revenue of approximately $135 million in the second quarter, which is down 41% from the second quarter a year ago, but up 31% from the first quarter.
Reports last week from peers LendingClub and LendingTree show that the consumer loan market is still shrinking and that could bode poorly for Upstart as it's subject to the same macroeconomic forces, including demand from its banking partners.
However, the company's focus on AI could give it an edge over its peers, especially considering the surge in demand for AI technologies this year.
Why Upstart still looks like a long-term winner
Even after this year's blockbuster gains, Upstart's market cap is still only $5.5 billion, showing there's plenty of room for the stock to be a multibagger, especially if it can return to strong growth in a more stable economy.
Upstart is targeting a multi-trillion-dollar loan market with plans to expand into home loans by launching a home equity line of credit product this year, and the business has continued to gain traction despite its financial numbers as the company now has 99 lending partners, up from 50 last year and 10 when it went public.
Its loans also continue to perform well, showing that its technology seems to be able to deliver through the entire credit cycle.
Given the size of the market and that it's competing with FICO scores, the upside potential for Upstart still seems to be enormous.
While the stock is likely to remain volatile over the coming months as consumer loans are down and the economy is uncertain, over the long term, this AI stock still looks like a winner.
