Upstart Holdings (UPST 2.76%) stock had a tremendous run last year, gaining 105% since the start of 2023. The company found relief when it was able to secure funding for its artificial intelligence (AI)-powered loans, and the stock bounced off its low price of around $12 per share and hasn't looked back since then.
Despite its massive rally, Upstart stock is still 93% below its all-time high price of $401 per share in October 2021. Upstart's AI-lending model has the potential to upend legacy credit scoring systems, but the company faces headwinds today that investors should understand. Let's examine them.
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A mission is to make credit accessible to all
Upstart's goal is simple: To make it easier for people to access loans by more accurately assessing risk. The company uses its homegrown AI consumer lending model with over 1,500 variables and 44 million repayment events to evaluate and price risk.
The company believes that traditional credit scoring systems, like Fair Isaac's FICO scoring system, shut people out of the financial system. Upstart believes that its lending models price risk better than competitors while doing it at a fraction of the cost. That's because a significant portion of its loans, over 89%, are fully automated from end to end, without any human intervention.
A vulnerability to interest rates
Upstart's stock got off to an incredible run after going public in December 2020. After closing near $30 per share on its first trading day, the stock surged 1,284% as consumer lending took off. What had investors most excited was that Upstart was a fresh IPO stock that was already turning a profit. In 2021, the company posted a net income of $135 million. It even announced a $400 million share repurchase program.
However, Upstart's success was short-lived. It turned out that ultra-low interest rates and easy lending conditions spurred a boom in personal loans. In 2021, Upstart made over 1.3 million loans totaling $11.7 billion.
However, consumer lending is a highly cyclical business, and in 2022, things began to slow down. That year, the Federal Reserve started raising its benchmark interest rate to get inflation under control. Rising interest rates had a ripple effect across lending activity, including consumer loans. Upstart saw strong demand early in the year, but that demand fell off in the second half as interest rates surged higher.
The biggest question facing the company entering 2023 was who would want its loans. Demand for loans from borrowers and their banking partners was tepid due to the uncertainty around interest rates. That was a big issue in 2022. Relief came in May when Castlelake, an alternative asset manager, agreed to buy $4 billion of Upstart's consumer loans, which kick-started a huge 400% rally in the stock.
Chart by author.
Headwinds will weigh on Upstart's business
Upstart continues to face headwinds. Its fourth-quarter earnings results beat analysts' consensus estimates. However, its guidance for 2024 was disappointing and suggested that the company's path to recovery would take longer than expected. Upstart guided for earnings of $125 million in the first quarter, well below analysts' estimates of $152 million and a $25 million EBITDA loss. Following its earnings announcement, the stock plunged nearly 20%.
One thing weighing on its near-term outlook is borrower delinquency trends. The company noted that delinquencies were rising among its higher FICO borrowers. Rising delinquencies will keep demand for consumer credit low, affecting its originations and net interest income. Demand will likely remain muted until credit conditions improve and/or interest rates come down, which could spur demand for its loans.
Buy, sell, or hold?
Near-term headwinds will weigh on the business and the bottom line, and the stock is likely to continue experiencing volatile price swings. Today, the stock is priced reasonably at around 4.4 times sales, well below its all-time high price-to-sales (P/S) ratio of 40 but also above its low P/S ratio of 1.1 last year.
Upstart's long-term growth potential is intriguing, especially if its lending models prove they can perform well when delinquencies are rising. However, near-term headwinds could cap its upside, so I'd consider the stock a hold for now.
