Upstart (NASDAQ: UPST) has taken its longtime shareholders on a wild ride. After shares skyrocketed 1,220% from their December 2020 IPO to their all-time high in October 2021, they have since fallen 94% (as of May 23).
The pessimism here fintech stocks has probably never been this high; this year it is down 43%. Investors who have an appetite for risk and the potential to earn high returns might want to keep an eye on Upstart as a possible addition to their portfolio.
Is this a no-brainer investment opportunity right now?
Influenced by macro forces
With the artificial intelligence (AI) boom in full swing, many investors are trying to gain exposure to this technology trend. To its credit, Upstart has been working to use AI and machine learning capabilities to better analyze consumer creditworthiness since its founding more than a decade ago. The company believes it can disrupt the traditional FICO scoring method, which only looks at five different factors. Upstart takes more than 1,600 variables into account before making a credit decision.
For the more than a hundred banks and credit unions that work with Upstart, this could theoretically lead to greater revenue potential. Being able to target a large potential customer base while managing the risk of default is an attractive proposition.
However, this sector has proven to be extremely cyclical and to struggle in a higher interest rate environment. The past few years haven’t been the best for Upstart, to put it kindly.
In 2023, the company reported a 59% decline in loan volume. This was in stark contrast to the 338% gain in 2021, when interest rates were much lower. Upstart’s revenue reflected this disappointing new trend.
Think about it from a consumer perspective: if interest rates are high, monthly payments will also be high, and this discourages people from taking out loans.
In addition to investors craving speculative growth tech stocks, Upstart’s poor fundamental performance helps explain why the stock has been crushed. At the time of writing, they are trading at a price-to-sales ratio of 3.7, which is significantly below their historical average.
Risk and uncertainty
Despite the cheap valuation, I still consider Upstart a very risky stock to own. Aside from the choppy revenue figures, the company is also burning cash. Over the past five quarters, Upstart reported $305 million in cumulative net losses. There’s really no telling when this trend will end.
Upstart’s supporters might argue that Now is a good time to buy the shares, with expectations that the Federal Reserve will cut interest rates in the not-too-distant future. In this scenario of looser monetary policy, there could be stronger demand for loans from borrowers. Then Upstart may be able to return to the monster growth and impressive profitability it recorded in 2021.
That sounds like a smart strategy, but it does require that you can correctly predict the direction of macroeconomic factors. No one, not even the Federal Reserve, knows when inflation will ease and when interest rates will start falling. What if the US remains in a higher interest rate environment for longer than expected? That would probably lead to a disappointing result.
Investors should wait until Upstart can report consistent revenue growth and positive earnings over a full economic cycle before considering buying shares. But it’s anyone’s guess when this might happen (or if it will even happen).
Ultimately, a good guideline is not to own companies that rely so heavily on favorable macro conditions for their success. Upstart has not shown that it does not belong in this category of companies.
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Neil Patel and his clients have no positions in the stocks mentioned. The Motley Fool has positions in Upstart and recommends Upstart. The Motley Fool has a disclosure policy.
These Cheap Stocks Are Down 94%: Is This a No-Brainer Investment Opportunity? was originally published by The Motley Fool
