Upstart (NASDAQ: UPST) went public in December 2020 at $20 per share. In less than 12 months, the stock rose 20-fold to $401 on the back of record-low interest rates, which boosted its artificial intelligence (AI)-powered loan origination platform.
Those tailwinds turned into headwinds in 2022 when the U.S. Federal Reserve aggressively raised rates, causing consumer demand for loans to plummet. The start-up companies’ shares then fell 97% from their all-time high to a low of around $12.
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However, Upstart’s AI lending performed well under challenging economic conditions, and the business is now on the rise. The stock price has risen back to around $78 at the time of writing, but that’s still 80% below its all-time high. I think a further recovery is on the horizon, so this is why investors may regret not buying the dip.
Banks have taken advantage Honest Isaac‘s FICO scoring system to determine the creditworthiness of borrowers since 1989. FICO uses five core metrics to determine a person’s ability to repay a loan, including the size of their existing debt and their payment history.
Upstart believes this approach is outdated. It designed an AI algorithm that analyzes 1,600 different metrics for a potential borrower to better understand their ability to repay a loan and help determine what interest rate they should be charged. AI can perform that analysis immediately, while it could take days or even weeks for a human reviewer. This also allows Upstart to automate as many as 91% of lending decisions, without human intervention.
When it comes to risk, Upstart’s latest AI model, called Model 18 (M18), makes 1 million predictions for each applicant to arrive at the right interest rate, which is six times the number of predictions the previous model could make doing. The end result is a fairer and more accurate outcome for the borrower.
Overall, Upstart says it approves of its AI-based approach double the number of loans compared to traditional valuation methods, at an interest rate that is on average about 38% cheaper. In other words, by analyzing so much data, Upstart is likely to capture thousands of high-quality deals that traditional appraisal methods miss.
Unsecured personal loans are Upstart’s bread and butter, but it also has a growing presence in the secured auto loan and home equity line of credit (HELOC) segments. Demand is currently increasing in all three countries because interest rates are falling.
Upstart operates an origination platform that approves loans for customers but then passes the loans on to lenders. If things are working properly, the company won’t keep these loans on the books. However, it used its own money to pay off some of the loans it initiated during a difficult period in 2022 and 2023, when partner financing dried up due to rising interest rates, and that is one of the reasons why the shares plummeted. Investors were not comfortable with the company taking on that credit risk.
Under normal circumstances, Upstart simply earns a fee every time the algorithm approves a request on behalf of its banking and credit union partners. These partners can also pay to license Upstart’s software so they can embed it into their own online loan application processes.
During the third quarter of 2024 (ended September 30), Upstart originated 186,786 unsecured personal loans, which was a whopping 65% increase from the year-ago period. There were also 1,080 car loans made, down year over year but up 53% from just three months earlier. The company announced a new financing deal with Blue Owl (an asset manager), which will buy $2 billion of loans over the next 18 months to help absorb growing demand.
That follows billions of dollars in deals with other external financing partners over the past year, as their risk appetite gradually returns. That’s essential, because Upstart must service loans to get paid and generate revenue growth.
In that regard, the company achieved total revenue of $162 million in the third quarter, an increase of 20% compared to the same period last year. It was the largest amount of revenue the company achieved in a quarter this year, and that 20% growth rate was a positive turnaround from the 6% decline in the second quarter.
The startups’ shares are up about 500% from their 2022 lows, so there’s definitely a recovery happening. However, it could continue for at least a few more years.
The company is on track to achieve total revenue of $587.5 million in 2024, which would be a 14% increase from 2023. But looking further ahead, the Wall Street consensus forecast (provided by Yahoo! Finance) shows that the company will generate revenues of $812.7 million. in 2025, which would mean an accelerated growth rate of 35%.
Shares of early-stage companies are currently trading at a price-to-sales ratio (P/S) of 12.4, which is a premium to the long-term average of 8.9 dating back to when the company went public in 2020 . However, based on Wall Street’s 2025 revenue forecast figures, Upstart’s forward P/S ratio is just 8.8, which is slightly below average:
In other words, investors willing to hold Upstart stock for at least the next year could get a good price now. However, the real opportunity will likely be realized in the longer term, as the company has identified as much as $3 trillion in annual lending in the form of unsecured personal loans, auto loans, home loans and small business loans in its addressable market.
Considering that Upstart has only made about $40 billion in loans in its history so far, it hasn’t even scratched the surface of its capabilities. If the company continues to execute on its strategy, long-term investors could reap significant rewards.
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Anthony Di Pizio has no positions in the stocks mentioned. The Motley Fool has positions in Upstart and recommends Upstart. The Motley Fool recommends Fair Isaac. The Motley Fool has a disclosure policy.
1 Super Stock Dropped 80% You’ll Regret If You Didn’t Buy on the Dip originally published by The Motley Fool
