Although Upstart (UPST 2.76%) stock is down 55% since the start of August, it has still soared 147% in 2023 (as of Aug. 23). That gain easily outpaces the Nasdaq Composite Index by an incredibly wide margin, likely driven by greater investor interest in businesses with exposure to artificial intelligence (AI).
When reporting its latest financial results, the fintech company provided weaker-than-expected guidance for the third quarter, helping drive shares lower. Investors could be eyeing Upstart as a potential opportunity right now.
It's best to consider both sides of the argument. Here's one reason Upstart looks like a screaming buy, as well as one reason to avoid the stock at all costs.
Finding a use case for AI
AI has been the hot buzzword in the corporate world throughout 2023. But before it was such a popular topic, Upstart had long been incorporating the technology into its operations as the key feature of its AI-based lending platform. The traditional Fair Isaac FICO model looks at only five factors to assess a borrower's ability to repay a loan, whereas Upstart looks at 1,600 variables. By being able to more thoroughly analyze a customer, Upstart says its system can approve more borrowers at lower rates. What's more impressive is that because the company uses AI and machine learning, its platform should only get better as it processes more data.
Financial services is a massive industry, so it's encouraging that Upstart is penetrating what appears to be a huge opportunity by focusing on disrupting the status quo. In the company's latest investor presentation, management highlighted that, in total, the markets for personal loans, auto loans, home loans, and small business loans have an origination value of $4 trillion. If Upstart can capture just a tiny sliver of this huge amount, revenue could skyrocket over time.
The company currently has 100 different lending partners using its platform, up from 71 a year ago. So a real product-market fit has been developed. Investors looking for an AI-powered business can do much worse than buying Upstart's stock.
A cyclical operation
All companies have some level of cyclicality to them, but in Upstart's case, it's amplified. The business's revenue and profit surged in 2021 thanks to low interest rates and heightened demand from borrowers. It's no wonder the stock was up 857% between the start of 2021 and its all-time high in October that year. It appeared Upstart could do nothing wrong.
But with the Federal Reserve aggressively hiking interest rates throughout 2022, the company was dealt a major blow. Last year, revenue fell only 1%, but Upstart posted a net loss of $109 million. Even more alarming, the number of loans the business was holding on its balance sheet was up significantly. Upstart relies on selling approved loans to third-party institutional investors. But because credit markets tightened thanks to the Fed's actions, this avenue wasn't as open last year as in 2021.
The troubles have continued this year. Throughout the first six months of 2023, Upstart's revenue declined 56%. It's now clear that Upstart depends very much on having a favorable macroeconomic backdrop to support its business. The company's struggles have been obvious, but what happens to the financials if the U.S. finally enters a severe recession? That's scary to think about.
Passing on the stock
Upstart's stock currently trades at a price-to-sales multiple of under 5, less than half its average trailing valuation ratio since the company went public in 2020. Investors are being presented with what looks like a good opportunity to buy an AI and fintech business.
But as compelling as that may be, I'm not rushing to buy shares just yet. Upstart's financial results are too unpredictable for my liking, and the company's financial situation isn't admirable, especially in an uncertain economic environment. Recessions are inevitable, so I'd much rather own businesses that can still post growth and positive net income in downturns, reducing overall portfolio risk.
