Upstart Holdings (UPST 9.57%) burst onto the scene during heightened market enthusiasm. But that excitement has since faded, as shares of this lending platform currently sit 93% below their peak about two years ago.
This company certainly has lots of potential, particularly as it relates to artificial intelligence (AI). And it's staring at a large market opportunity. However, it's always a good idea to be cautious and understand downside risk factors.
Let's look at why this fintech stock is a screaming buy, but also consider one important reason that it's best to avoid being a shareholder for now.
The positive traits
Probably the most attractive characteristic about Upstart is its huge growth potential. For starters, there is a clear need for the type of service that Upstart provides. By integrating AI and machine learning, the business allows its 100 lending partners to approve more borrowers, while at the same time controlling for default risk. The result is greater revenue potential for those lending partners and access to affordable credit for borrowers who might be shut out by traditional banks.
Unlike the traditional FICO credit scoring system, which looks at five key factors, Upstart's platform analyzes more than 1,000 variables about a prospective borrower to better assess risk. Some investors -- at least initially -- were enamored of this disruptive technology, which aims to upend what management believes is an outdated process.
So, the product has some market fit. Next, Upstart is staring at a huge opportunity, as the markets for personal, auto, home, and small business loans are worth about $4 trillion in annual origination value. With transaction volume of just $34 billion in its entire history, Upstart has a huge expansionary runway to penetrate.
It's also worth mentioning that Upstart has long focused on using AI to underpin its business. This company is not just riding the hype of this new technology to find success. It's been ahead of the curve, a strategy that deserves some credit.
Investors who care primarily about growth and innovation might not hesitate to buy the stock right now, especially since it's been so beaten down in the past couple of years.
Investors should be patient
Despite Upstart's positive attributes, there's one huge red flag. And that relates to how cyclical this business has proven to be. That's alarming for some investors who bought into the stock thinking Upstart's financials would behave like those of a high-growth tech company, as opposed to a regular lending institution.
Even though Upstart relies on third-party lenders to approve and fund loans, its financials are still fully exposed to macro factors. And this is an unfavorable trait, in my opinion.
Revenue through the first six months of 2023 declined 56% on a year-over-year basis. And in the latest quarter, transaction volume was down 64%. It's not surprising that higher interest rates, especially at the pace that the Federal Reserve has raised them at, will discourage borrowers from wanting to take out loans.
After posting net income of $135 million in 2021, Upstart posted a net loss of $109 million last year and $157 million combined in the past six months. So not only is demand susceptible to falling off a cliff, but this business can start losing lots of money, too. Whatever happens with the macro picture is outside Upstart's control, and this has a profound impact on its financial performance. This should worry investors because they don't know with a high degree of confidence if the company can even survive over the long term.
To be clear, Upstart would be a no-brainer stock to buy if it can increase revenue and maintain consistent levels of profitability through an entire economic cycle. But at the current time, it's not putting on a good show, no matter how well its AI-powered model works.
This means that investors will have to be patient for now, sitting on the sidelines until there are concrete improvements.