Upstart(NASDAQ: UPST) It went public in December 2020 at a price of $20 per share. In less than 12 months, its shares rose 20-fold to $401 thanks to historically low interest rates, which were a tailwind for its artificial intelligence (AI)-powered loan origination platform.
That tailwind turned into a headwind in 2022, when the U.S. Federal Reserve aggressively raised interest rates, driving down consumer demand for loans. The upstart stock proceeded to plunge 97% from its all-time high to a low of around $12.
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However, Upstart’s AI originated loans performed well in difficult economic conditions and its business is now on the rise. Its share price has returned to around $78 as of this writing, but is still 80% below its all-time high. I think a bigger recovery is on the horizon, so here’s why investors might regret not buying the dip.
The banks have used just isaacA person’s FICO scoring system has been used to determine the creditworthiness of borrowers since 1989. FICO uses five basic metrics to determine a person’s ability to repay a loan, including the size of their existing debt and their payment history.
Upstart thinks that approach is outdated. It designed an artificial intelligence algorithm that analyzes 1,600 different metrics to help a potential borrower better understand their ability to repay a loan and help determine the interest rate they should be charged. AI can perform that analysis instantly, while a human evaluator could take days or even weeks. That also allows Upstart to automate a staggering 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 6 times the number of predictions you could make. its previous model. The end result is fairer and more accurate for the borrower.
Overall, Upstart says its AI-based approach allows it to pass double the number of loans compared to traditional underwriting methods, at an interest rate that is around 38% cheaper, on average. In other words, by analyzing so much data, Upstart is likely capturing thousands of high-quality deals that traditional evaluation methods miss.
Unsecured personal loans are Upstart’s bread and butter, but it also has a growing presence in the secured auto loans and home equity lines of credit (HELOC) segments. Demand is increasing in all three right now because interest rates are falling.
Image source: Getty Images.
Upstart operates an origination platform that approves loans for customers but then transfers them to lending partners. If things are working as they should, you don’t keep those loans on your books. However, it used its own money to service a portion of the loans it initiated during a difficult period in 2022 and 2023, when partner funding dried up due to rising interest rates, and that’s one of the reasons. why its shares plummeted. Investors were not comfortable with the company taking on that credit risk.
Under normal circumstances, Upstart simply earns a fee each time its algorithm approves an application on behalf of its bank and credit union partners. Those partners can also pay to license Upstart’s software so they can integrate 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 represented a whopping 65% increase over the prior-year period. It also originated 1,080 auto loans, down year over year but up 53% from just three months earlier. The company announced a new financing agreement with Blue Owl (an asset management company), which will purchase $2 billion worth of loans over the next 18 months to help absorb that growing demand.
This follows deals worth billions of dollars with other external financial partners over the past year, as its risk appetite gradually returns. This is key because Upstart has to service loans in order to receive payments and generate revenue growth.
In that sense, the company generated $162 million in total revenue during the third quarter, 20% more than in the same period of the previous year. It was the most revenue the company generated in a quarter this year, and that 20% growth rate was a welcome change from the 6% drop it generated in the second quarter.
The upstart stock is up around 500% from its 2022 low, so a recovery is certainly underway. However, it could continue for at least the next few years.
The company is on track to generate $587.5 million in total revenue in 2024, which would be a 14% increase from 2023. But looking further ahead, Wall Street’s consensus forecast (provided by Yahoo! Finance ) suggests the company will generate $812.7 million in revenue. during 2025, which would mark an accelerated growth rate of 35%.
The upstart stock is currently trading at a price-to-sales (P/S) ratio of 12.4, which is a premium to its long-term average of 8.9 since the company went public in 2020. However, according to Wall Street’s 2025 forecast Based on revenue forecasts, Upstart’s forward P/S ratio is just 8.8, slightly below its average:
UPST PS Ratio Data by YCharts
In other words, investors willing to hold Upstart stock for at least the next year could get a good price right now. However, the real opportunity will likely materialize in the long term, because the company has identified a whopping $3 trillion in annual loan originations in its target market across unsecured personal loans, auto loans, mortgage loans and small business loans.
Considering that Upstart has only originated about $40 billion in loans so far in its history, it hasn’t even scratched the surface of its opportunity. If the company continues to execute its strategy, long-term investors could reap substantial rewards.
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Anthony Di Pizio has no position in any of the stocks mentioned. The Motley Fool has posts and recommends Upstart. The Motley Fool recommends Fair Isaac. The Motley Fool has a disclosure policy.
1 Super 80% Stock Drop You’ll Regret Not Buying on the Dip was originally published by The Motley Fool
