With the artificial intelligence (AI) craze at an all-time high these days, investors are looking for ways to get exposure to this new technology. A company like Upstart (UPST 0.60%), which has developed a disruptive AI-powered lending service, might be on your radar right now.
If you're an investor looking to add shares of Upstart to your portfolio, however, you should think twice. It's better to buy PayPal (PYPL 1.61%), a magnificent fintech stock, instead. Here's why.
Upstart's business has been struggling
NASDAQ: UPST
Key Data Points
Upstart provides its technology to banks and credit unions, which use the platform to better analyze the creditworthiness of borrowers. The business earns fees anytime its system helps to originate loans. Since its founding in 2012, Upstart has approved $35 billion of loan volume.
Over time, growth has been notable. However, in the past couple of years, it has become obvious how sensitive Upstart is to macroeconomic factors, especially higher interest rates. The business was experiencing monster growth and generated sizable net income in 2021, but this was when the U.S. central bank was more accommodating.
In 2023, though, things took a huge turn for the worse. Revenue declined 46% year over year in the first nine months last year, and Upstart posted a net loss of $198 million during this time. This helps explain why the stock is currently sitting 91% below its all-time high, even though it soared more than 230% last year.
The company's struggles make sense. When interest rates are higher, demand from borrowers will be under pressure. This leads to a very cyclical enterprise that has yet to prove that it can add revenue and report positive earnings over a full economic cycle.
In my opinion, Upstart is a very risky stock that should be avoided.
PayPal has numerous positive attributes
NASDAQ: PYPL
Key Data Points
Despite persistent macro headwinds, PayPal continues to post healthy gains. Revenue increased by 8% through the first nine months of 2023, and total payment volume was up 15% in the latest quarter compared to the same periods in 2022. Consumer discretionary spending might not be as strong as it was during the depths of the pandemic, but this company is still growing, which is obviously a positive sign.
It's very easy to find reasons to like PayPal's business. Its digital wallet is the most widely accepted among the top 1,500 merchants in North America and Europe, ubiquity that makes PayPal a leading brand in the payments industry. Engagement continues to rise as transactions per active account increased by 13% in the last quarter.
PayPal's competitive position is protected thanks to the presence of network effects. Having 35 million merchants and 393 million individuals on the platform creates a two-sided system where the growth of one type of user immediately benefits everyone else. It's a virtuous cycle that gets stronger over time.
Conversely, I'm not sure if Upstart possesses an economic moat right now. To its credit, it has developed proprietary technology utilizing AI and machine learning. But there's nothing stopping the big banks that dominate lending activity from working on their own innovative lending systems.
As of this writing, PayPal shares are a huge bargain. They trade at a forward price-to-earnings ratio of just 11. This is about the cheapest they have sold for in the last three years. The pessimism is sky-high.
It's hard to pinpoint exactly why the stock fell 14% in 2023 and is 80% off its peak price. But slowing growth might deserve the blame. These worries are overblown, given that PayPal is still posting solid gains.
At the beaten-down valuation, investors are getting a competitively advantaged and profitable enterprise that is in no way running into financial troubles anytime soon. That seems like a good bet.
So forget about Upstart. PayPal easily looks like the better stock to buy and hold for the long term.
