You remember Upstart Holdings (UPST 2.76%), right? The AI lending company whose stock went viral, soaring to nearly $400 per share in 2021 on pandemic stimulus checks and low-interest rates?
If you don't know Upstart, it's probably because the stock plummeted out of the spotlight, falling to as low as $12 as the FOMC cranked up rates to cool inflation in 2022. If you're like me, someone who still holds the stock, you might want to check your blood pressure. It's been an exhilarating ride up and a demoralizing ride down.
Jokes aside, Upstart remains in flux, showing promising technology but fighting economic headwinds.
As fourth-quarter earnings approach, let's discuss whether investors should buy, sell, or hold the stock today.
This is Upstart's problem
Upstart is an AI company trying to upend the lending industry. Traditionally, prospective borrowers are judged by their credit score when applying for a loan. Instead, Upstart uses proprietary algorithms and artificial intelligence to evaluate creditworthiness. Management claims its technology can pick out risky borrowers five times better than FICO, enabling 53% fewer defaults at the same approval rate and a better user experience for borrowers, including automating 88% of loans.
The company makes most of its money on referral fees. Rather than holding the loans, Upstart steers borrowers to a network of over 100 partner banks and credit unions. Essentially, Upstart is drumming up loans for its partners for a fee. The problems started in 2022 when the FOMC rapidly raised interest rates to combat soaring inflation.
This had multiple consequences for Upstart.
First, rates rose so quickly that it soured the profitability of some of Upstart's loans, forcing management to hold them on its balance sheet. Its loans also underperformed for a stretch, hurting trust with Upstart's partners. Fortunately, loan performance has improved as Upstart adjusted to higher rates:
Image source: Upstart Holdings.
All of this caught Upstart off guard. Initially, it was a funding supply problem, meaning Upstart was getting more loan applications than it could handle. It arranged some committed funding to address that. However, Upstart had to charge higher interest on loans to make money as rates kept cranking higher. Now, Upstart has the opposite problem: not enough loan demand.
Big-time potential despite the headaches
It's clear now that Upstart's business is susceptible to the broader economy and interest rate policies. Upstart thrived, then fell on its face when the economy changed. Rightfully, a lot of blame falls on management for that. So, what's the good news?
Well, it seems that Upstart's technology works, which means the business could bounce back when the economic climate again favors Upstart. The company has expansion potential beyond personal loans, including automotive lending and home equity lines of credit. Ideally, diversifying the business will stabilize it so that it's not feast or famine like this in the future.
Lastly, Upstart was highly profitable when the business was thriving. It earned $2.37 per share in 2021 when Upstart had a fraction of its current lending partners. It seems reasonable that Upstart would be profitable again when the business improves.
Buy, sell, or hold?
The million-dollar question is when a turnaround will happen. Unfortunately, it's not likely to be after the company's fourth-quarter earnings announcement. The company tracks a proprietary metric it calls its Upstart Macro Index (UMI). It weighs many variables to determine how the broader economy is likely to impact Upstart's loans:
Image source: Upstart Holdings.
At 1.73, the index is at its highest level in three years. The reading indicates that Upstart's loans are 73% more likely to default than its long-term averages due to economic conditions. That's not ideal.
As a shareholder, I'll be looking for management to comment on the outlook for 2024 and will check the pulse on Upstart's financials to ensure the balance sheet isn't taking on too many loans.
Everyone must decide for themselves, but I haven't added shares since the business got turned on its head and will likely wait until there is clear evidence that Upstart's struggles are behind it. That makes the stock a hold today. Upstart stock will remain risky until the economy improves and the company cleans up the weaknesses that got it here in the first place.
