Many executives believe artificial intelligence (AI) will fundamentally change how the economy functions. While many businesses have been working urgently and investing massive amounts of money to take advantage of the trend, Upstart (UPST 0.07%) has been developing its AI platform for several years already.
This fintech enterprise is impressive, particularly from a tech perspective and based on its objective. However, investors should avoid the stock like the plague. Here's why.
Mixing fintech with artificial intelligence
Upstart is riding two major technological waves. The first one is the crossroads of finance and technology, known as fintech. The other, as I just mentioned, is AI. This could draw investors interested in these two areas.
This business is trying to disrupt how credit is approved. Upstart's AI platform analyzes 1,600 variables about potential borrowers to gain a more thorough understanding of their ability to repay a loan. This can boost access to credit for people who might be shut out of the traditional FICO-based system, which has been around since 1989 and only considers five different factors.
For Upstart's more than 100 lending partners, the AI can help approve more borrowers while controlling default risk. That's a winning combination, because it can lead to greater revenue and profit potential.
An attractive aspect of any early-stage tech enterprise is the prospect of monster growth. Upstart currently handles personal and auto loans on its platform, two markets that combined have $839 billion in annual origination volume in the U.S. With plans to offer home loans ($1.4 trillion market volume) and small business loans ($895 billion) one day, the market opportunity appears to be significantly larger.
Upstart shares soared in the first 10 months following its initial public offering in December 2020. However, the stock has come crashing down, now trading 93% below its peak. The current price-to-sales ratio of 4.2 is less than half the historical average. This might entice investors to take a chance on the stock, but that's not a smart idea.
NASDAQ: UPST
Key Data Points
Don't buy Upstart stock
Investors should think twice before buying Upstart. For starters, the past couple of years have proven how extremely cyclical its operations are. And that's very alarming.
In 2021, the company was firing on all cylinders. Revenue that year was up 264% year over year, and Upstart even reported $135 million in net income, good for a 16% margin. But the Federal Reserve's aggressive rate hikes have created a major headwind, leading to notable sales declines as fewer people want to take out loans at higher rates.
This leads to another negative trait of this business, which is that its success is extremely sensitive to factors beyond its control. Of course, the economy is not in any company's control, but Upstart is overly reliant on a robust macro backdrop, especially low interest rates. Plus, it needs credit markets to function smoothly so there is demand from institutional investors to buy Upstart's loans.
To be fair, all financial services specialists experience some level of cyclicality. That alone isn't a reason to panic. But what makes this situation worse is that Upstart hasn't proven that it can be consistently profitable. In the last eight quarters, the business has reported $446 million in cumulative net losses. It's anyone's guess when this will change.
I'm also wary of the actual size of Upstart's addressable market. While lending markets are indeed massive, I'm skeptical this business will command any meaningful share over time. The big money-center banks -- JPMorgan Chase, Bank of America, Wells Fargo, and Citigroup -- handle a sizable chunk of all lending activity in this country. Plus, they have the resources to develop their own digital and AI capabilities, so they'll probably never partner with Upstart.
These unfavorable characteristics add tremendous amounts of uncertainty to Upstart's long-term picture. Consequently, owning the stock is a high-risk endeavor, at least until there are major improvements from a fundamental perspective.
