The tech sector took a beating this year, with the Nasdaq-100 index down 28%. The contraction is being driven by soaring inflation and rising interest rates, which are holding back the economy and forcing investors to rethink their growth expectations.
This is hurting some companies more than others. Equity investments born (UPST -0.69%), for example, it uses artificial intelligence (AI) to lend to banks on other lenders, and investors doubt how well its lending models will withstand deteriorating household finances. To make matters worse, loan demand is plummeting as the economy falters.
As a result, the Upstart stock tumbled 94% from its all-time high. But stocks could be very attractive at today’s prices, with the potential to offer solid long-term returns for investors who buy now.
Loan demand is slowing, but demand for Upstart is skyrocketing
Upstart’s main goal is to replace the standard tools used to measure risk in consumer lending. Handsome IsaacFICO’s FICO credit score system has been the gold standard for decades, but Upstart says its criteria are too narrow to serve potential borrowers in the modern economy.
Instead, Upstart uses artificial intelligence to determine a person’s creditworthiness by evaluating up to 1,600 data points. Since AI works much faster than humans, it can provide immediate decisions on around 73% of loan applications. This is a big cost saving for banks.
In the second quarter of 2022, Upstart’s algorithm generated $ 3.2 billion in loans, a modest 17% year-over-year increase. But it represented a 27% drop from the $ 4.5 billion it originated in the first quarter of 2022, marking a rather sharp slowdown.
But there was a bright side. The number of banks and credit unions adopting the Upstart algorithm has continued to grow year after year and since the first quarter.
Likewise, Upstart continued to add partnerships with car dealerships. There are now 37 major brands using Upstart Auto retail and loan software in 640 US dealerships.
Therefore, even as consumer credit demand is waning, Upstart could be preparing for a strong rebound when the economy recovers.
But there are challenges
Many investors doubt that Upstart’s credit models will survive during a sustained economic downturn. After all, they were developed in good times and not battle tested.
Loan defaults are increasing across the lending industry as US government stimulus programs related to the pandemic have been closed. However, Upstart had expected this and says its models are calibrated for an economy far worse than the slow growth of a few years after the financial crisis.
But investors buying some of the Upstart-originated loans were certainly scared, and the company stepped in to fund loans worth $ 623 million using its balance sheet. This is a big no-no from a risk standpoint as far as the stock market is concerned; however, the company says it intends to sell most of these that do not relate to genuine research and development.
In a recent presentation, the company said that its AI-based approach continues to have an edge over traditional credit scores and that its accuracy has steadily improved over time, even during this tumultuous second quarter. ‘year. If this remains the case, any funding problems should be relatively short-lived.
Upstart actions are very interesting
After falling 94% from its all-time high of $ 401.99, Upstart’s current share price of around $ 23.65 gives the company a $ 1.9 billion valuation. But here’s the thing: He has $ 757 million in net worth on his balance sheet, including a $ 790 million pile of cash.
If you withdraw that cash, investors basically value Upstart’s actual business at just $ 1.23 billion, even though it has generated over $ 1 billion in revenue in the past four quarters. On top of that, Upstart was profitable in 2020, 2021 and the first half of 2022 despite the difficult economic environment, and not something you often see from a fintech startup.
Concerns about the company’s AI-powered lending models will likely not be resolved for a few more quarters. Investors will also want to see Upstart follow plans to sell loans on its balance sheet.
Proceeding with cautious optimism might be the smart plan here. The upstart stock is so shot down that it could generate successful long-term returns for investors who buy it now, provided the company’s assumptions are correct and its lending patterns don’t collapse even as the economy deteriorates.
Anthony Di Pizio has no position in any of the aforementioned titles. The Motley Fool has locations and recommends Upstart Holdings, Inc. The Motley Fool recommends Fair Isaac. The Motley Fool has a disclosure policy.