It's been a roller-coast ride for stockholders of Upstart Holdings (UPST 2.76%) lately. Shares of the AI-based lending platform saw about half their value wiped out in a matter of days as investors panned its earnings report for the second quarter of 2023. Before this decline, the stock had risen approximately sixfold as it appeared on track for a recovery.

Despite this negative news, the investment case may not be as impaired as the stock's recent performance might imply. Here's why investors should stick with this stock or add it to their portfolios.

Upstart's Q2 earnings

The company's financials speak to the depressed state of today's lending market. Its $136 million in Q2 revenue fell by 40% from the same quarter last year. And despite significant cuts in operating expenses, the $28 million loss for Q2 was only a slight improvement from the $30 million loss in the year-ago quarter.

But what may have disappointed investors most was Upstart's Q3 guidance, which it has set at $140 million. Analysts had previously expected around $155 million versus $157 million in the third quarter of 2022.

Consequently, the massive stock price increases of the last few months abruptly reversed course. While the 160% increase so far this year is still a stunning return, it is well below the 445% yearly gain investors could have claimed at the beginning of August.

Why Upstart may still look attractive

Amid Upstart's decline, the price-to-sales (P/S) ratio has fallen to 5. That is well above the P/S ratio of just 1 from the beginning of the year, but the sales multiple remains historically low. Still, since the stock's performance tends to depend on interest rates, investors should be careful not to overpay for this stock.

Despite the perils of owning Upstart, it may be worth owning for one critical reason: its model appears to work. It is an improvement over Fair Isaac's FICO score, which has not experienced a major overhaul since its introduction in 1989. Upstart's model considers more variables and incorporates AI into its calculations. Consequently, it can approve 43% more loans without increasing the bank's risk of default.

As of the end of Q2, 100 lending partners now use Upstart, up from 71 a year ago. Likewise, 61 auto dealerships offer Upstart-powered loans versus 39 one year ago. Additionally, CEO Dave Girouard announced on the Q2 2023 earnings call that Upstart fully automated the approval of a record 88% of its unsecured loans, allowing banks to originate loans more efficiently.

Finally, Upstart started a pilot program offering home equity lines of credit (HELOC) in Colorado. That takes Upstart into the $2.2 trillion home lending market. In comparison, the combined markets of personal, auto, and small business loans amount to about $1.8 trillion. This is critical because expanding its addressable market could begin to mitigate the revenue declines Upstart has suffered in today's rising rate environment.

Investing in Upstart

Upstart is not for the faint of heart, and its history shows that the level of interest rates has dramatically increased or reduced revenue. However, with the opportunity to transform the loan evaluation market through AI, it could eventually surge much higher.

The company's ability to weed out more delinquent borrowers provides a valuable service to banks at a time when reducing risk has become more critical. Moreover, its move into additional loan markets could help compensate for the business lost to rising rates. As more lenders partner with Upstart, both banks and investors should benefit over time.