Upstart (UPST 0.26%) drew lots of investor attention early on for its efforts to upend the way borrowers take out loans. Its AI-powered lending platform targeted an industry that some would argue is in need of a change. The positive attention it got early on led to some rapid growth and helped drive share prices up 857% from the start of 2021 to their all-time high price in October of that year.
But since hitting that peak, this fintech stock has cratered roughly 94% and the business is working through some challenges. While some investors might view the beaten-down shares as a solid long-term opportunity, I won't consider buying Upstart stock until there's some serious improvement in this one key factor. Let me explain.
There is cause for concern with Upstart
The biggest warning sign I've seen with Upstart is that the business is much too vulnerable to the cyclicalities of the broader economy. Shareholders who bought the stock when it hit the public markets in December 2020 likely thought Upstart would perform more like a technology business than a traditional bank.
Through the first nine months of 2023, revenue fell 46% versus the year-ago period. That led to Upstart posting a net loss of $198 million over that time. This financial performance is in stark contrast to the company's results from just a couple of years ago. Revenue jumped 42% in 2020 and 264% in 2021, with Upstart being profitable in both years.
The company's volatile financial results from year to year are closely tied to the macroeconomic environment. In 2020 and 2021, interest rates were kept low to support economic growth following the onset of the coronavirus pandemic. This favorable backdrop created a strong demand from borrowers for loans.
But quickly rising inflation in 2021 pushed the Federal Reserve to embark on an aggressive campaign of hiking interest rates (a policy move that is still in effect). Higher rates lead to tighter lending standards from banks and lowered demand for loans from potential borrowers. It's no wonder Upstart's financials took a serious hit.
NASDAQ: UPST
Key Data Points
Upstart needs to get on a sustainable path
As of Sept. 30, Upstart had $517 million of cash on its balance sheet. This means that it can handle several quarters of losses at the current pace before it runs out of liquidity and would need to access the capital markets to raise cash. But what if there's a severe recession on the horizon? Losses would surely increase in this scenario. This is something investors have to worry about.
So what can Upstart do to tamp down this warning sign and prove that this cyclicality won't be such a factor? I think it's pretty simple. I need to see loan volumes and revenue both grow on a yearly basis throughout an entire economic cycle, regardless of what the macro backdrop looks like. Of course, growth will be better when rates are lower, but if Upstart can still expand its business when times get tough, that would be a positive development.
Perhaps more importantly, I need to see consistent profits from this company. As noted earlier, Upstart would probably be in trouble if a severe recession happened. Investors looking to allocate their savings into long-term holdings don't want to worry about the survivability of the companies they own. And this is precisely the thing to worry about the most as it relates to Upstart.
Uncertainty is high for Upstart's stock
It's understandable that investors with a tolerance for risk and a strong desire for growth stocks would still want to own this stock. Upstart is putting AI and machine learning to use and developing a truly innovative lending tool. In a world that is only becoming more digital, there's certainly potential here.
It also helps that shares got so hammered. They trade at a price-to-sales multiple of less than 4, well below the historical average of 10.1.
But with the warning sign still flashing bright red, I view Upstart as too risky of a stock to own.
