Upstart Holdings (NASDAQ: UPST) is a good example of irrational exuberance in action. Throughout 2021, a flurry of excitement around fintech pushed its stock price higher by leaps and bounds. In mid-October, the stock peaked at $ 401.49 per share, representing a return of 1.907% from its initial public offering less than a year earlier. However, despite strong economic results, valuation concerns have since brought the stock to the ground, and stocks are now trading 78% below all-time highs.
After this sad sell-off, is the Upstart stock a smart buy? Let’s dive.
In a mission to modernize the lending industry
Banks often build their lending models Timios Isaachis FICO rating, a three-digit number intended to reflect how creditworthy a particular borrower is (or is not). The standard FICO scorecard is based on 12 to 20 variables, and while banks often incorporate other criteria, many of the more advanced credit models do not take into account more than 30 variables.
Upstart sees this as a problem, arguing that banks often do not have enough data to properly quantify risk when making lending decisions. As a result, some creditworthy borrowers are excluded from the system and many who are approved end up paying too much interest because they have to subsidize the part of the borrowers who will inevitably go bankrupt. For example, 80% of Americans have never defaulted on a loan, but only 48% qualify for basic prices.
Upstart aims to make the credit industry more efficient. Provides lenders with a range of tools for verifying borrower identity, bank account verification and credit decision making, as well as alerting for loan side effects and loan servicing. Most importantly, its platform captures over 1,500 data points per borrower – far more than traditional credit models – and measures these variables relative to previous repayment events to quantify risk.
This way, every time a borrower makes or loses a payment, Upstart’s AI model becomes a little smarter. Management believes that the network phenomenon is a significant competitive advantage and it is difficult to challenge the results.
How to measure the real impact of Upstart AI models
Internal studies indicate that Upstart’s artificial intelligence platform is quite effective. Compared to traditional credit models, it can reduce defaults by 75% while maintaining approval rates or it can increase approvals by 173% by maintaining default rates. Either way, lenders are making more money, which means they can afford to offer lower interest rates to consumers. Of course, internal studies are not the same as real-world results.
Fortunately, investors can collect some data on the repayment of Upstart-backed loans through companies such as the Kroll Bond Rating Agency (KBRA). How does this work? Many of the loans backed by Upstart are actually raised and sold to investors as asset-backed securities. KBRA periodically reviews these titles and publishes the results for free. According to a report filed in April 2022, KBRA reduced its loss forecasts for all Upstart securities issued between 2018 and 2020 and some issued in 2021. KBRA did not increase its loss forecasts for any securities. This is good news for shareholders.
However, delays are growing faster in more recent titles. For the framework, keep in mind that Upstart has not been tested during a credit crunch. Interest rates have been relatively low over the last decade and until mid-2021, inflation it was mild for years. But now, with inflation at a 40-year high, borrowers are likely to have less cash available, which could lead to higher losses.
It is still too early to draw conclusions. At this time, shareholders should be pleased with the results of KBRA analysis, but should continue to monitor the performance of Upstart-backed loans over the coming quarters and years.
Disrupting a multi-trillion dollar market
Upstart grows like a fire. As of December 31, 2021, the company has 38 banking partners on its platform, more than three times what it had a year earlier. Even better, trading volume (the sum of all loans coming from its platform) increased by 241% to $ 11.8 billion in 2021. In turn, revenue soared 264% to $ 849 million and the company created free cash flow $ 153 million, up from $ 10 million in 2020.
Going forward, Upstart has abundance growth margin. His platform is currently being used to build personal loans and car loans, two markets that include a $ 820 billion opportunity. For the foreseeable future, Upstart’s trading volume of $ 12.8 billion in 12 months means that it occupies less than 2% of its current address market. But the administration has even greater ambitions. The company plans to expand into new areas of the lending industry, including $ 4.6 trillion in mortgage lending and $ 644 billion in small business lending.
In short, Upstart is upsetting a multibillion-dollar industry, with stocks now trading at 10.3 times sales – near the bottom of their historical range – now seems like a good time to buy it growth stock. Of course, there are no guarantees that Upstart will ever regain its former highs, but given its incredible financial performance and huge market opportunities, I think it’s worth the risk.
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