All investors want to find winning stocks. But I think investors can seriously improve their skills by identifying which businesses to avoid. This not only saves time for you to move on to the next idea, but it can also help eliminate what might turn out to be potential money-losers.
Based on its recent challenges, which are hard to ignore, I believe Upstart (UPST -1.50%) falls squarely into this category. I wouldn't touch this fintech with a 10-foot pole. Here's why.
Ongoing struggles
Upstart markets itself as the leading artificial intelligence (AI) lending platform. Since its founding in 2013, the company has built a tool that its more than 100 banking partners can use to approve borrowers and lend money. Compared to the traditional FICO scoring method, Upstart analyzes over 1,600 unique variables about consumers to better assess their creditworthiness. The business certainly deserves credit for working on AI capabilities long before this technology became such a hot topic.
Just like the banks and credit unions that it serves, Upstart's operations have proven to be alarmingly cyclical. And that's a troubling sign, as the fundamentals can swing from positive to negative unpredictably.
When interest rates were low in 2021, Upstart's loan volume, revenue, and profits soared. It's no wonder the stock hit a record high in October that year. Demand from borrowers, as well as lenders' willingness to approve the loans, was robust.
This situation has drastically changed as the Federal Reserve has really tightened its grip on the economy. Higher rates have crushed Upstart. And with inflation remaining sticky, the circumstances may not change anytime soon.
In 2023, Upstart's loan volume and revenue dipped 59% and 38%, respectively. Even worse, the company reported a net loss of $240 million. Not as many people want to take out loans when rates are so high.
The business just reported financial results for the first quarter of 2024. Upstart's growth resumed, but that was based on extremely easy comparable data in the year-ago period, when sales cratered 67%.
According to the management team, the tough times are set to continue. It expects revenue to total $125 million in the current quarter, which would represent an 8% year-over-year decline.
There's really no telling when Upstart's situation will improve. It all depends on changes in interest rates and the state of the economy, which are hard to know ahead of time.
A high-risk play
Unsurprisingly, poor financial performance has resulted in a beaten-down stock. As of this writing, Upstart shares trade 94% off their peak price. To be fair, they look cheap, selling at a price-to-sales multiple of 4.0 right now. That's well below the historical average multiple of 9.4.
Some daring investors might view the stock as a high-risk/high-reward play. That's understandable, as Upstart does possess sizable growth potential. Executives tout a $3 trillion total addressable market (amount of annual originations in personal, auto, home, and small business loans). Even if Upstart's platform captures a tiny sliver of this, the upside is huge.
The issue I have, though, is that I don't have confidence in Upstart's ability to achieve steady growth and consistent positive earnings throughout a full economic cycle. If it ever gets to this point, which looks increasingly unlikely, then the company might be a more compelling investment opportunity. I'm not optimistic.
Throughout most of its history, Upstart has operated in a very favorable macroeconomic backdrop, with tempered inflation and extremely low interest rates. This might not be the case over the next few years. And that makes it incredibly easy to be bearish on this business.
