With a bull market in full swing, is it finally time to dip into some of those high-risk, high-reward stocks that usually soar when investors are enthusiastic? It's certainly time to consider buying some, as long as you do your due diligence and understand the risks and opportunities.

Wall Street is excited about many of the artificial intelligence (AI) stocks that abound and are changing the way consumers shop, pay, stream, and more. Pagaya Technologies (PGY 7.33%) uses AI to assess credit risk and create more lending opportunities, and Wall Street is predicting great things from this relative newcomer.

What does Pagaya do?

Pagaya operates a credit evaluation platform powered by AI that helps lenders of all kinds assess consumer credit risk. Pagaya has relationships with many top brands you know and use, including Visa for its credit card risk management, as well as banks like Ally Financial and SoFi Technologies. For example, it works with Ally, which has been expanding its consumer lending business, to identify pre-qualified credit card customers.

Many lenders are feeling the pinch of high interest rates and are reporting lower sales and margins. But Pagaya continues to demonstrate strength, with increasing sales and improving profits. In the 2023 third quarter, revenue increased 4% year over year, and network volume was up 10%. That may not sound impressive unless you understand that competitors are reporting significant declines. Revenue from fees less production costs (FRLPC), its baseline profitability metric, rose 29% and expanded as a percentage of revenue. Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) turned positive after a loss the year before, and adjusted net income was $14 million.

Pagaya has been attracting new business as it demonstrates its value, and it recently recruited an unnamed top-five U.S. bank by assets for a personal lending product. It also onboarded a large auto retailer, a real estate company, and more. Management says that 80% of the top 25 U.S. banks are in its pipeline. Between expected interest rate cuts that could trigger an increase in lending and all of this new business, 2024 could be an incredible year for Pagaya.

Two-sided model

Pagaya sells its loans to financial institutions as asset-backed securities (ABS), gaining money to use for new loans. It has been able to source and obtain pre-funding rounds from varied investors. It got $6.6 billion in funding in 2023, and it already announced a new round of $400 billion in funding so far in 2024. Pagaya is the top issuer of ABS loans in the U.S.

Pagaya might be looking to expand into new territory, which could increase its market opportunity. According to The Wall Street Journal, it bid to acquire a company called GreenSky that provides loans for home improvement after Goldman Sachs sold it off in October. It didn't win the bid, but it might be looking for alternative acquisitions.

Risk vs. reward

Pagaya is a young company in a risky business. It's highly vulnerable by interest rate changes and fluctuations in the economy. It's faring quite well under current circumstances, which indicates resilience. But there are still unknowns, and it's still not profitable on a generally accepted accounting principles (GAAP) basis.

Pagaya stock is down 81% from its first-day opening price and 57% from its 52-week high. That's partially for the above-mentioned reasons but also because investors are still wary of companies highly connected to interest rate trends.

However, the future looks very bright. The average Wall Street consensus is for Pagaya stock to gain 163% during the next 12 to 18 months, and five of six analysts covering it recommend to buying it. One analyst, Michael Legg from Benchmark, set his price target to $6, implying a 426% gain. He sees the company's resilience in the current, challenging conditions, as well as its opportunity, as justifying a much higher valuation. At the current price, Pagaya stock trades at a price-to-sales ratio of less than 1.3, which is a bargain for a high-growth stock. While not all analysts agree here, his case looks compelling.

Management gave a recent update that it plans to relocate its headquarters from Tel Aviv to New York because most of its business and all of its lending partners are in the U.S. It also plans to authorize a reverse stock split. Pagaya stock trades for just over $1 as of this writing, and it hopes that a higher price and U.S. base will afford it and shareholders better opportunities, such as the chance for inclusion in certain indexes and to be considered for investment by institutions.

Should you buy Pagaya stock today? If you have an appetite for risk, you may want to open a small position. Even if you don't, you should keep Pagaya stock on your watch list.