It's been a wild ride for Upstart (UPST 2.90%) shareholders. Although the stock is down considerably this year, it has skyrocketed 99% since the start of 2023 (as of April 3). That gain has crushed the broader Nasdaq Composite index by a wide margin.
Investors who might want to buy the recent dip in the hopes of achieving outsized long-term returns will want to think twice. That's because this fintech stock has a hidden risk.
Exposed to interest rate trends
Investors who strive to own shares in businesses over the long haul, say five or 10 years, should want these companies to ideally be able to grow revenue and report positive earnings each year. Doing this regardless of economic conditions is the sign of a durable enterprise.
Unfortunately, Upstart doesn't fit this category. Instead, the business has proven to be extremely cyclical, not representing a traditional tech company investors had hoped for. The fact that Upstart is hugely exposed to broader macro factors, particularly interest rates, is its primary risk.
Just look at the last few years. Upstart was posting remarkable revenue and loan growth in 2020 and 2021. In that latter year, the company saw sales rise by a whopping 264%, and it reported $135 million of net income. It's not a surprise the stock was up an incredible 857% from the start of 2021 to its peak in mid-October that year.
This was when the Federal Reserve was being very accommodative, keeping interest rates low to spur the economy following the coronavirus pandemic. In this favorable backdrop, demand from borrowers to take out loans was not only strong, but lenders wanted to approve these loans. It's a winning situation for Upstart.
NASDAQ: UPST
Key Data Points
But when the Fed started rapidly hiking interest rates in 2022, primarily to put a lid on soaring inflation, it created a terrible scenario for Upstart to thrive. Revenue and loan volume started falling off a cliff in the second half of 2022, weakness that continued throughout last year. And the business continues registering huge net losses each and every quarter.
To be fair, perhaps every company out there experiences some kind of cyclicality. The good news, though, is that the economy is expanding for longer periods of time than it's contracting. This means businesses should do well in the long term.
That is, if they can demonstrate being in a strong financial position. This obviously hasn't been the case with Upstart. And it makes owning the stock an extremely risky proposition, as the company is likely to run into financial troubles again at some point in the future.
Bigger picture
Upstart is aiming to disrupt how lenders assess borrowers' ability to repay loans. The business claims it uses over 1,000 unique variables about consumers before making a decision. This can lead to lower defaults and higher approval rates, exactly what Upstart's over 100 banking partners want.
Even better, the company has been working with artificial intelligence (AI) for over a decade now, way before it became a hot buzzword that's the talk of Wall Street. Upstart's founders have clearly found a true use case for AI within the financial services industry. And given that massive scale of different lending verticals in the U.S., valued in the trillions of dollars annually, Upstart is staring at what looks like a huge opportunity.
This all sounds wonderful on the surface, but there's a lot of uncertainty about what the next five or 10 years look like for this company. Unless Upstart gets back to posting solid growth and consistent profits, investors should stay away from the stock.
