Many millionaire-making stocks weren't obvious winners at first. Tesla almost went bankrupt years back, but that would have been the best time to invest as the stock generated life-changing returns over the following years.
Upstart Holdings (UPST 2.76%), which uses artificial intelligence (AI) to evaluate consumer creditworthiness for loans, could be at a similar fork in the road. The business is fighting extreme adversity, but there is an undeniable upside if things work out in the long run.
Don't get the wrong idea -- Upstart's stock is extremely risky today. But you only need a small amount to create huge returns if Upstart succeeds, and if it doesn't you'll be glad you only bought a small amount.
Check below for what makes Upstart a moonshot AI stock with millionaire-making potential, along with its associated risks.
Millionaire-maker? Here is why it could be
Upstart wants to replace credit scores as they currently exist, because it believes AI can better determine whether borrowers can repay their loans. It's a cool idea, and Upstart's AI technology has merit. Upstart states its software results in 53% fewer defaults at the same approval rate because it can separate bad borrowers from good four times better than a standard credit score. It publishes data to support this.
Investors should never underestimate superior technology, especially when the market opportunity is as enormous as Upstart's. Lending is a pillar of the economy, and the addressable market between personal, automotive, and home loans amounts to trillions of dollars. Upstart's market cap is just $2 billion today. That makes the stock an easy multi-bagger if its technology continues to work and more lenders use it across the lending industry.
A fundamentally flawed business model
The above narrative sounded great when low interest rates encouraged consumer borrowing a few years back. But rates eventually skyrocketed in response to inflation, which turned Upstart's business on its head.
Upstart felt a squeeze from both ends of its business. Higher rates not only forced Upstart to charge higher interest, turning borrowers away, but lenders also grew reluctant to trust Upstart's loans, erring on the side of caution as bank failures spooked lenders last year.
Personal loans are unsecured, meaning no assets back them in the form of collateral. Upstart's reliance on personal loans has become a serious flaw at the heart of its business. Management is trying to adapt by pursuing funding partners and expanding to home and auto loans, but it's a tough slog that's moved slowly without interest rates easing up much.
For now, Upstart's lending volume has suffered so much that the company is now burning cash:
UPST Revenue (TTM) data by YCharts
Should investors buy the stock?
Upstart is very profitable when things are going well. The company earned $2.37 per share in 2021, and its current goal is to evolve in a way so it doesn't feast or famine with personal loans. However, the current state of the business puts investors in a bind because the metaphorical ship is taking on water.
The company wants to offload the loans it approves to its partner lenders and institutional buyers, but has gotten stuck holding loans it can't move. Loans held were up to $1.15 billion as of Q4. Meanwhile, Upstart's cash balance fell to $468 million from $615 million just three months earlier. Upstart has laid off employees and cut costs to slow its cash burn, but it's clear that time is running out for Upstart's business to improve, either through changes or from an improving lending environment.
Investors shouldn't panic about bankruptcy because it's doubtful all $1.15 billion of Upstart's loans will default, so that will be money coming back to the company.
But Upstart doesn't have the business fundamentals to inspire investor confidence -- it's not even close right now. That could change over time, and that's what makes the stock a potential millionaire-maker. But its long-term fate looks like a coin toss, so investors would be wise to keep Upstart as a tiny piece of a diversified portfolio.
