Is Upstart Stock a Buy?

Perhaps no other topic has gotten more attention in 2023 than artificial intelligence (AI). Investors are constantly looking at ways to allocate capital behind what could prove to be a revolutionary technology.

But while many companies in the industry struggle to find any real-world use cases, Upstart (UPST 5.40%) was founded more than a decade ago with a focus on utilizing this tech to better assess credit risk of potential borrowers. In other words, it has found product-market fit.

Is this AI-powered lending platform a smart buy right now? That’s likely the important question that investors are asking. Here’s what you should know before making an informed decision.

Booming in good times

Upstart offers its tech platform to lending partners like banks, credit unions, and auto dealerships, collecting fee revenue anytime loans are approved using its system. Growth was impressive in 2020 and 2021, primarily thanks to ultra-low interest rates and a strong economy. In fact, in 2021, the company saw loan volume and revenue soar 338% and 264%, respectively, on a year-over-year basis.

These types of gains propelled the stock to new heights. From Upstart’s opening price of $20 at its initial public offering in December 2020 to its all-time high in October 2021, shares rose more than 1,200%. It appeared as though the business could do no wrong in the eyes of shareholders.

Recent struggles

Upstart was founded in early 2012, so it really hasn’t had to deal with much of an economic slowdown throughout its entire history (besides the brief pandemic-induced recession). This makes the past 18 or so months, ever since the Federal Reserve started quickly raising interest rates, the first true test for the business. And things haven’t gone smoothly, to say the least.

Higher rates have reduced demand for loans, which isn’t a surprise. And Upstart continues to feel the pain. Its platform helped originate 34% fewer loans in the latest quarter than in the year-ago period. This led to a 14% decline in revenue. Making matters worse, Upstart’s financials keep taking a hit. Through the first nine months of 2023, net losses totaled $198 million.

The positive spin on all this is that Upstart’s AI models should get better over time, particularly as they handle more data in different economic environments. However, the issue is that these models can’t do anything about demand trends from borrowers. That’s completely outside the company’s control. And it makes Upstart a very cyclical enterprise.

The investor perspective

I believe there are two ways to view this situation. On one hand, Upstart’s shares have gotten so hammered that some investors might be willing to take on the risk. The stock trades at a price-to-sales multiple of 3.9, which is well below the historical average valuation. Getting in at a lower price point increases the potential upside.

Growth-minded investors who care about owning disruptive companies will likely have no problem taking a small position in Upstart today. After all, the economy spends more time in expansion mode than it does in a downturn. The thinking is that when the economy bounces back, as it has historically, Upstart’s financials will get a boost.

That all sounds good and well. However, I side with those investors who are a bit more cautious. To its credit, Upstart does offer an innovative product that has lots of potential. But I need to see revenue growth and consistent profitability no matter what the macro picture looks like. Plus, if the U.S. remains in a higher-rate and higher-inflation environment for the next few years, that could seriously hurt loan demand.

These negative factors result in me staying away from Upstart stock for now.

Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Upstart. The Motley Fool has a disclosure policy.

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