Upstart (UPST 2.76%) shares have been a big winner this year, as they have skyrocketed a jaw-dropping 230% (as of Dec. 14). Investors are becoming more optimistic about this business once again.
However, the shares still are about 90% below their all-time high. So this lending-focused fintech stock might be on your radar as a potential investment opportunity to buy on the dip.
There's one huge red flag that the business could face in 2024 and beyond, though, that will temper your expectations. Here's what you should know about Upstart.
Upstart has sizable potential
By integrating machine learning and artificial intelligence (AI), Upstart has developed an innovative lending platform that can more accurately assess borrowers' creditworthiness. Whereas the traditional FICO model looks at just five variables, Upstart considers more than 1,600 factors. The result is a system that approves more loans and keeps defaults under control. Moreover, credit availability increases for people who might struggle to get approved via regular methods and channels.
As we've seen this year, there is no shortage of bullishness when it comes to the potential of AI. In Upstart's case, it has already found a real-world use case by mixing this technology with lending. There is clear demand, which is something a lot of AI start-ups can't say.
Since its founding in 2012, Upstart's platform has helped to originate $35 billion worth of loans. But that figure barely scratches the surface of the bigger opportunity. Across four lending segments -- personal, auto, home, and small business loans -- the annual origination value of $4 trillion in the U.S. gives Upstart a huge runway.
Upstart certainly has a lot of growth potential, should everything work out in its favor and it gains greater adoption. This is what bullish investors are hoping for.
Investors can't ignore a key red flag
Almost two years ago, the Federal Reserve started to admit that inflationary pressures weren't transitory after all. This forced the central bank to embark on aggressive interest rate hikes in 2022 and 2023. These tighter credit conditions have an effect on all businesses, but those that are exposed to lending activity are affected the most.
This points to the major red flag about Upstart's business that investors need to understand. That's the undeniable fact that this company is overly sensitive to macro factors, which it has absolutely no control over.
On the one hand, Upstart benefits tremendously in low-rate environments. In 2021, revenue surged 264%, which helped propel the stock to its peak price late that year.
But on the other hand, when rates go up and stay up, demand for loans dwindles. In the third quarter, Upstart's platform originated 34% fewer loans than in the year-ago period. Revenue declined 14%, and the business posted a net loss of $40 million.
This is not something that gives me confidence as an investor. If higher interest rates are the new normal, at least for a while, it will definitely create a more difficult macro backdrop for Upstart to register strong growth and rising profits. And this could pressure the stock.
I'm not smart enough to accurately predict when the economic mood will turn from uncertainty and pessimism to optimism and enthusiasm. I don't think there are any investors who can do this on a consistent basis. This makes owning Upstart a risky endeavor.
Changes in interest rates are unpredictable. As they relate to Upstart, this will be the key theme to watch in 2024. Depending on how things play out, they can be a headwind or a tailwind for the company. This uncertainty, though, is a red flag -- and it's why I'm staying away from the stock.
