At one point this year, Upstart (UPST 2.76%) shares were up an astonishing 445%. But even though the stock has dropped 58% since that recent high, propelled by troubling second-quarter financial results, it has still crushed the broader market in 2023.
Investors have a lot to think about with this fintech company. But before deciding to buy shares, it's best to gain a full understanding of both the good and the bad with this artificial intelligence (AI)-powered lending platform.
Upstart's favorable qualities
Thanks to its use of AI, Upstart is trying to disrupt the lending industry. Its models can better assess a borrower's risk, leading to more accessible credit for those who might be refused at regular banks. Since its founding in 2012, the business has helped originate $34 billion in loans. And as of June 30, Upstart had 100 different lending partners using its technology. By allowing its partners to approve more loans while controlling defaults, Upstart has proven to be a winning solution for all stakeholders.
The company's main lending products are personal loans and auto loans, but management is also focused on penetrating the market for home loans and small-business lending. Combined, these four verticals present a $4 trillion opportunity. That's a truly massive addressable market. Unsurprisingly, Upstart's growth has been notable. Revenue in 2022 totaled $842 million, almost 15-fold more than in 2017.
Taking all of these factors into account, it's easy to see why some investors, primarily those who are interested in disruptive companies that possess growth potential, would be drawn to Upstart.
Reasons to pass on the shares
Despite the positive attributes I discussed above, which are definitely compelling, I think investors should avoid buying the stock right now. There are valid reasons to adopt this way of thinking.
Take the financial picture, for example. In the first six months of 2023, Upstart's net loss totaled $157 million. To be fair, this year hasn't been friendly to many corporations, but this demonstrates that the company is far from being consistently profitable.
To its credit, Upstart posted positive net income of $135 million in 2021. That was due to low interest rates, loose lending standards, and strong demand from borrowers for loans. In other words, the macro environment was very favorable for Upstart. As 2022 came along and the Federal Reserve started hiking interest rates, it was a different story.
Any investor who is seriously considering buying the stock today needs to accept just how cyclical this business is. Typically, tech companies are compelling for investors because they tend to grow no matter what's going on around them. Upstart proved that it fit into this category for much of its history, but last year showed that despite heavily marketing itself as an AI enterprise, its financial performance mimics that of a traditional banking entity. That makes me worried.
To add another point about how dependent this company is on favorable macroeconomic factors, consider that Upstart's business model relies on its ability to sell the loans it originates to third-party investors. This requires the presence of robust credit markets enabling the flow of capital, which is something entirely outside of Upstart's control.
Upstart's poor financial performance has happened during a time when economists and financial analysts think the U.S. economy has shown resilience, with a recession not yet here. What happens in a real recessionary scenario? Is there a possibility that Upstart simply doesn't survive? These are questions that any prospective investors should be asking, particularly as it relates to thinking about downside risks.
In my opinion, there are just too many red flags to recommend buying the stock right now.
