Is Upstart Stock a Buy?

In the first 10 months after the initial public offering in December 2020, the shares of upstart (UPST -3.69%) rose 1,220% to peak in October 2021. Investor sentiment towards the business could not have been higher.

But like many pandemic-era darlings, Upstart fell out of favor. Its shares are now more than 90% below their all-time high of nearly three years ago.

It is this fintech stock a smart buying opportunity right now? Let’s consider both the bull and bear arguments as they relate to Upstart.

Upstart’s innovative AI lending model

There is so much talk about artificial intelligence (AI) and how it could upend so many industries. But investors shouldn’t forget that Upstart has been ahead of this tech trend, as AI has underpinned its entire business since its inception more than a decade ago.

Upstart operates an AI-powered lending model that analyzes more than 1,000 variables about a potential borrower to more accurately assess credit risk. The widely used FICO model, which was adopted in 1989, looks at just five key factors. Because the company believes it has better control over a customer’s ability to repay a loan, Upstart claims its system can lower default rates and approve more borrowers.

This is a winning combination for the company’s more than 100 lending partners, which include banks and lenders. Even better, Upstart enables a seamless workflow without human interaction. In the second quarter, 91% of its loan approvals were fully automated.

Until a few years ago, the company’s growth trajectory was remarkable. In 2021, Upstart saw a monster revenue gain of 264%. This was driven by a 338% increase in loan volume. The company even reported positively generally accepted accounting principles (GAAP) net income of $135 million that year.

Management believes the company’s opportunity is huge. In the US, combining the markets for personal loans, auto loans, home loans and small business loans brings us to a figure of $3.1 trillion. Over its history, Upstart has facilitated $39 billion in loans, so there’s still a big runway to try to capture. This does not even include the credit industries in international markets.

Upstart is a very cyclical business

While growth has been superb during ultra-low interest rates, Upstart has shown that its operations are highly cyclical. Higher interest rates have been a headwind as demand for loans from both consumers and institutional investors has been reduced.

In 2023, the company posted revenue of $514 million and transaction volume of $4.6 billion, down 38% and 59%, respectively, from the previous year. The upstart finally returned to growth in the first quarter of this year, but then revenue fell again in the second quarter.

The company is also bleeding money. Its net loss totaled $119 million in the first half of this year, after losing $240 million in the same period in 2023. So not only is the upstart struggling to find growth, it’s in a position very precarious financial position.

It has become strikingly clear over the past two years how dependent the company is on having a favorable edge macro backgroundmainly in terms of low interest rates, for its success. This is not ideal for investors because macro factors are unpredictable.

With the possibility of interest rate cuts on the horizon, perhaps Upstart’s situation will begin to improve. However, if an investment opportunity requires you to time the economic cycle correctly for it to work, then it’s probably not a useful place to park your capital.

Upstart’s AI model is innovative and engaging. But even though the stock is currently trading at a price-to-sales ratio below its historical average, this is a business you should not own right now.