Few technologies have the potential to change the world like artificial intelligence. From search results and digital ads to cybersecurity and insurance, AI can harness the power of big data to make systems more accurate and efficient.
Upstart (UPST +4.47%) brings these transformative technologies to the consumer credit industry, aiming to improve the lending processes for both banks and borrowers. Here's why this stock could grow tenfold in the next decade.
Image source: Getty Images
Big market opportunity
Fair Isaac invented the FICO score in 1989, giving lenders a way to determine who qualified for a loan and at what interest rate. Since its debut, this methodology has become an industry standard, and Fair Isaac's clients now include 95 of the 100 largest financial institutions in the U.S. and half of the top 100 banks in the world.
However, Upstart believes the current system is outdated and inefficient. To that end, its platform leans on big data and artificial intelligence, providing lenders with a more modern solution. As a result, banks benefit from greater approval rates, lower fraud and loss rates, and a highly automated lending process; and consumers benefit from greater access to credit and lower interest rates, because they aren't subsidizing borrowers who default.
Initially, Upstart focused on personal loans, an industry worth $84 billion in United States. But last June the company expanded into auto loans, adding $635 billion to its market opportunity. However, over $4.2 trillion in consumer loans are originated each year in the U.S., and Upstart plans to grow its business across new verticals over time. In short, the company has a tremendous market opportunity.
Image source: Getty Images
Strong competitive position
Upstart benefits from a significant data advantage. It collects 1,600 details per applicant, far more than the 12 to 20 variables considered by a FICO scorecard. Then Upstart trains that data against 10.5 million repayment events (and counting), creating AI models that more precisely quantify risk.
In fact, a study during the COVID-19 pandemic found Upstart's AI models to be five times more predictive of credit risk than traditional lending frameworks. At the same time, a report from the Consumer Financial Protection Bureau indicates that Upstart's technology boosts approval rates by 27%, while also lowering the average interest rate by 16%. This win-win scenario for banks and borrowers creates a self-reinforcing network effect.
As more loans are originated through the Upstart platform, the company collects more repayment data, sharpening its predictive engine. And as Upstart's AI models become more intelligent, its lending partners can approve more loans at lower interest rates, which should bring even more applicants to the platform.
This virtuous cycle has already been a significant growth driver.
|
Metric |
2018 |
Q2 2021 (TTM) |
CAGR |
|---|---|---|---|
|
Revenue |
$99.3 million |
$452.2 million |
83% |
Data source: Upstart SEC filings, Ycharts. TTM = trailing-12-months CAGR = compound annual growth rate.
It's also worth noting that Upstart is profitable on a GAAP basis. The company reported a profit of $0.51 per diluted share through the first half of 2021, up from a loss of $0.32 per diluted share in the first half of 2020. That's encouraging, since Upstart went public less than a year ago.
However, there are also two risk factors that investors should consider: First, Cross River Bank accounted for 63% of Upstart's revenue last year, meaning the loss of this one client would be a big blow. At the same time, 52% of Upstart's web traffic arrived by way of Credit Karma, meaning the company is highly dependent on this partnership.
Despite the potential headwinds, I'm not too worried about either situation. Even if the company loses both partners, Upstart would still have troves of consumer data, meaning its AI models would continue to improve over time, making its remaining partners more efficient. And that value proposition would help the company onboard new clients, eventually replacing the lost revenue.
Here's the bottom line: Given Upstart's clear advantage -- more data and better AI models -- this fintech company could disrupt the multi-trillion dollar consumer credit industry in a big way. If that happens, it's not hard to imagine Upstart growing into a $160 billion business a decade from now. Put another way, with a current market cap of $16 billion, I think Upstart can grow tenfold in the next 10 years.
