Upstart Holdings (UPST 2.65%) is a prime example of what could happen if you buy a stock when its valuation becomes unsustainable. After its price-to-earnings ratio hit north of 400, it finally began to deflate, and its stock is now down 94% from its highs.
Investors seem to have lost confidence in Upstart stock for the time being anyway. But what about the future? Let's see what's in store for Upstart over the next year and whether or not it's a bargain at the current price.
A great concept, only in good times?
Upstart's business is an artificial intelligence (AI) driven platform that helps lenders evaluate credit risk. It's able to assess many more criteria than the traditional scoring model because it uses thousands of data points and machine learning to make complex decisions instantly. It says it approves 44% more loans without adding risk to the lender at 36% lower rates.
That's game-changing, because more loans turn into more money for lenders in the form of interest. It also creates more opportunities for borrowers who otherwise might not be approved according to traditional standards.
It's easy to see why Upstart stock completely exploded when it went public. It had its initial public offering (IPO) at a time when interest rates were near zero, making it easy for borrowers to avoid defaults. Upstart's system was able to identify plenty of good borrowers under these conditions.
However, it was untested in high-interest rate conditions, and as soon as interest rates went up, Upstart's business plummeted. The loan industry is under pressure, with fewer borrowers looking for loans when interest rates are sky high. And those who are biting the bullet anyway aren't being approved at the same pace as before, since the high-interest rates mean a greater likelihood of defaults for many borrowers.
Upstart's sales and volume have declined heavily in this environment, and profits have evaporated.
What's happening now
Upstart demonstrated some improvement in the 2024 first quarter. Revenue increased 24% year over year to $128 million, but it's still well below previous highs. Net loss was $64.6 million, about half of what it was the year before.
It has 100 credit partners and keeps adding more, and its auto loan product has 103 dealer rooftops, up from 39 last year. It recently launched its first home loan product -- a home equity line of credit (HELOC), which is now live in 16 states plus Washington, D.C. It's also seeing momentum in its small dollar loans, which offer relief for some borrowers who aren't eligible for a personal loan.
Management has taken several steps to reduce costs and get into a better position financially, considering there's less money coming into the organization. It cut jobs and reallocated resources to cover priorities, and it's cutting out storage costs.
What could happen over the next year
What happens over the next year really depends on what happens to interest rates. The Federal Reserve had indicated lowering rates as early as March, but taming inflation has so far proven to be a challenging task. If rates go lower, Upstart's business should improve, although it will take time for the rate changes to trickle down to higher volume and sales to the bottom line. The longer rates remain high, the longer it will take Upstart to demonstrate progress.
CEO Dave Girouard said that he expects positive earnings before interest, taxes, depreciation, and amortization (EBITDA) by the end of the year. But management is guiding for performance to worsen in Q2. It's expecting revenue to decrease from $136 million last year to $125 this year and net loss to widen from $28 million to $75 million despite all of its cost cutting.
Strictly from an operational standpoint, Upstart should be better off in a year from now than it is today. It's doing the right things to improve its business and be as efficient as possible under the circumstances. It's unlikely to be net profitable, but it should be moving in the right direction.
Finally, it's important to note that until recently, Upstart stock has been extremely volatile. But this year, the market doesn't seem to have the stomach for this kind of volatility, and has moved on from this stock.
However, investors who are potentially interested in adding Upstart to their portfolios should closely keep an eye on Upstart's stock, because if the share price jumps from just forward-looking good news (like it has in the past), it could quickly become expensive from an earning perspective. But the euphoria could be short-lived when the market realizes that the lender's fundamentals may take a long time to reflect the market's initial enthusiasm. And that's a good reason to pass the stock in the short term even if the outlook begins to improve.
