Stocks like Nvidia, Microsoft, C3.ai, and Advanced Micro Devices (to name a few) have surged over the past year. Much of those returns have been driven by one thing: artificial intelligence (AI).
In fact, Goldman Sachs says a record-high 36% of all companies in the S&P 500 mentioned AI in their conference calls with investors in the fourth quarter of 2023. Clearly, there's a belief this technology will attract investors.
However, Upstart Holdings (UPST 0.81%) proves AI isn't always a magic bullet. Its stock went public in 2020 at $20 per share. It surged over 2,000% to an all-time high of $401 in less than a year, but it has since lost 93% of that value to trade at just $26.19 as of this writing -- despite being one of only a few companies successfully monetizing AI.
I'll explain the decline below, and whether the steep drop in Upstart stock could be a buying opportunity.
NASDAQ: UPST
Key Data Points
AI can't overcome surging interest rates
Banks and financial institutions tend to use the FICO credit scoring system when assessing the creditworthiness of a potential borrower, but Upstart believes that approach is outdated. After all, FICO only factors in five metrics like a person's repayment history and existing debts. Upstart's AI-driven models, on the other hand, measure 1,600 different data points to gain a better understanding of overall creditworthiness.
As a result, Upstart says its algorithm approves 44% more loans, at an interest rate that is 36% lower than traditional assessment methods. Plus, 89% of approvals are instant and entirely automated, which is a win for Upstart's bank partners, because analyzing over 1,000 data points manually (with human assessors) would be incredibly time-consuming and expensive.
As a loan originator, Upstart doesn't lend any money itself. Instead, the company uses its technology to approve loans for more than 100 banks. Upstart's models were originally trained to assess unsecured personal loans, but the company has expanded into car loans and home equity lines of credit (HELOCs), and that list will probably continue to grow.
Unfortunately, the U.S. Federal Reserve raised the federal funds rate from 0.25% to 5.50% between Mar. 2022 and Aug. 2023, which sent loan demand plummeting among consumers. Borrowing money is now much harder and more expensive than it was just a couple of years ago.
Upstart originated 437,659 loans in 2023, which was down a whopping 61% from 1.1 million loans in 2022 -- and that number was already down 5% from 2021.
Upstart's revenue plunged in 2023 as a result
Upstart delivered $560.4 million in revenue during 2023, down 38% from the previous year. That forced the company to drastically adjust its cost structure. It slashed 20% of its workforce at the start of 2023 and reduced its marketing spending 63% for the year. Any time a company cuts costs -- especially marketing expenses -- it becomes even harder to generate growth.
Unfortunately, those reduced expenses weren't enough to prevent Upstart's net loss from more than doubling to $240 million in 2023. Falling revenue and soaring losses are a surefire recipe for a lower stock price.
Upstart's management team expects the broader economic conditions to normalize in 2024, which will be a tailwind for its business. The Fed is also forecasting three interest rate cuts this year, and Wall Street thinks there could be as many as four cuts. That would take some pressure off consumers and likely reignite demand for credit.
Some of that optimism is baked into Upstart's forecasts. It expects to deliver $125 million in revenue for the first quarter, which would be a 21% increase year over year.
Is Upstart an AI stock to buy on the dip?
Despite the turbulent year in 2023, Upstart's technology is a game changer. The company said 92% of automatically approved applications converted to funded loans in the fourth quarter of 2023 -- that's more than 3x higher than the industry average of 27%.
Consumers tend to go cold when dealing with lengthy approval processes, so automation can lead to substantially more loans for Upstart's bank partners.
Plus, the addressable opportunity in the lending industry is enormous. Around $3 trillion worth of loans are originated in the U.S. each year across four categories: personal loans, car loans, mortgages, and small business loans. Upstart is active in the first two, and it has exposure to the home loan segment through its HELOC product, which is now active in 12 states.
The company has a long and potentially slow recovery ahead, but Wall Street thinks its full-year revenue will return to a modest growth rate of 8% in 2024. Current estimates also point to an acceleration to 23% growth in 2025.
Therefore, given the steep 93% drop in Upstart stock from its all-time high, now could be a great time to buy -- not just because of its AI pedigree but because its business might genuinely be on the upswing. However, investors should be mindful of the stock's severe volatility, which can be unnerving.
