Holdings reached (NASDAQ: UPST) is an AI-powered fintech whose mission is to improve consumers’ access to credit. The company went public in December 2020 and has already caught the attention of Wall Street – the stock price has climbed 155% in the past three months alone.
Following these big gains, many investors are probably wondering the same thing: is it too late to buy Upstart? In situations like this, it’s important to take a step back, put aside any fear of missing out and consider the situation dispassionately. With that in mind, let’s take a look at Upstart’s business from top to bottom.
Here’s what you need to know.
Traditionally, banks have made lending decisions based on a consumer’s FICO score, a three-digit number generated from just 12 to 20 data points. This metric is used to assess creditworthiness, helping lenders decide who is eligible for a loan and at what interest rate. But Upstart believes this methodology to be flawed, and management cites flaws like this: Four in five Americans have never defaulted on a loan, but less than half of those people have a credit score that would allow them to benefit from the lowest rates offered by banks.
In an effort to solve this problem, Upstart is relying on artificial intelligence. Specifically, its platform captures over 1,600 data points per borrower, then measures that information against 10.5 million repayment (and counting) events. In doing so, Upstart’s AI models get a little smarter every time someone makes or misses a payment, helping their banking partners quantify risk more precisely.
Upstart initially tackled personal credit, but has since spread to auto loans. Collectively, these markets represent a $ 719 billion opportunity, but the company plans to enter other markets in the future (e.g., student loans, mortgages, credit cards), targeting more largely to the $ 4.2 trillion consumer loan sector.
Upstart is a pioneer in the AI-powered lending space. It was founded in 2012 and the company has been upgrading and training its AI models for over eight years. This head start is an important advantage, as it means that Upstart has more data and a higher quality loan product.
Plus, its platform creates value on both sides of the equation. Consumers benefit from higher approval rates and lower interest rates, and banks benefit from access to new customers, a highly automated lending process, and lower fraud and loss rates . In fact, compared to traditional loan models, Upstart increases approval rates by 27%, while lowering the average interest rate by 16%, according to the Consumer Financial Protection Bureau (CFPB).
However, the CFPB released these statistics in 2019, and Upstart’s AI models have improved significantly since then. In fact, management estimates their platform to be four to eight times more accurate than traditional lending models. And this is true regardless of the macroeconomic context. Upstart’s AI models were five times more predictive of financial hardship than credit scores during the COVID-19 pandemic, according to an internal study.
Generally speaking, Upstart’s business model creates a network effect. By allowing banks to offer more loans at lower interest rates, Upstart should attract more borrowers to its platform. In turn, these borrowers are expected to generate new data points, making Upstart’s AI models even better at quantifying risk. And this should further strengthen the ability of its banking partners to approve more borrowers at lower interest rates.
This virtuous circle has been a powerful engine of growth. Despite the headwinds created by the pandemic, Upstart provided 300,379 loans in 2020, up 163% from 2018. In addition, the percentage of fully automated loans – that is, loans without human involvement – reached 70% in 2020, compared to 53% in 2020. 2018. And during this two-year period, revenue increased by 53% on an annualized basis.
More recently, this growth has accelerated. In the first six months of 2021, Upstart provided 456,610 loans, up 375% from the previous year. Revenue jumped 288% to $ 315.3 million, and the company posted positive GAAP earnings of $ 0.51 per diluted share. In short, Upstart’s financial performance has been impressive.
Worth the risk
When I look at Upstart the biggest red flag I see is rating. The company now has a market cap of $ 25 billion and the stock is trading at 60 times the absurdly rich sales. For this reason, I would recommend caution. Now is definitely not the time to put your savings in Upstart, and if you choose to invest, know that you are off for a bumpy ride.
That being said, Upstart has a huge market opportunity and a strong competitive position, and I think its disruptive approach to consumer credit could translate into tenfold growth over the next decade. Also, while the stock certainly looks expensive today, there is no guarantee that it will soon be cheaper.
So is Upstart a buy? In situations like this – if I’m very interested in owning a stock – I tend to ignore the valuation and open a small position. Then I try to build that position over time using the average dollar costs, with the goal of buying at lower valuation multiples along the way.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.