Upstart Cuts Guidance: Here’s Why Investors Shouldn’t Panic

It can be disconcerting to see a stock plummet nearly 20% in a single day, especially after it has already crashed to $33 per share from an all-time high of $401 in just the past nine months. And yet, as dire as this price drop may seem to investors, they should know that Assets received (UPST -2.92%) still has significant long-term potential as a stock. He just has to find a way to navigate this difficult economic environment.

Management of the AI-focused fintech specialist has just announced preliminary results for the second quarter of 2022, and it revealed that revenues will be below expectations, even if these forecasts had already been revised downwards a while ago. a few months old.

This is bad news. There is no denying it. But here’s why investors should view this setback as a buying opportunity for Upstart’s stock, rather than a sell signal.

The Upstart Difference

Upstart is a real disruptor. It strives to provide an AI-based loan assessment model to replace Just Isaacit is (FICO -0.78%) decades-old FICO credit score system. Upstart management says FICO is no longer the ideal reflection of creditworthiness that it was three decades ago when banks first adopted it, because the economy has changed significantly since then. The modern workforce is more educated and often earns income outside of the traditional 9 to 5 employment model. Upstart assesses over 1,600 data points about a potential borrower to generate a more accurate loan assessment.

Upstart’s algorithm can make a decision instantly about 74% of the time, and a study has found it reduces default rates by up to 75% compared to traditional credit scoring models. It’s a winning proposition for the company’s 60 partner banks and credit unions.

The company usually does not lend money itself; instead, it creates loans for banks that pay Upstart a fee to do so. This means that Upstart is running a very capital-intensive business, allowing it to already be profitable, which is rare for a relatively young tech organization. But amid tighter credit conditions in recent months, its balance sheet had to temporarily absorb $597 million in loans as its banking partners’ appetite to buy them waned. It was also keeping the loans longer as part of the R&D needed to help it grow its expanding auto loan program.

Commentary from Upstart’s preliminary Q2 report suggests that these loans have now been sold, but potentially at a loss. This appears to be one of the main reasons the company’s revenue was hit in the second quarter, but it is positive that this credit risk has disappeared.

Upcoming management assesses the damage

In the first quarter, Upstart cut its full-year 2022 revenue forecast from $1.4 billion to $1.25 billion. And since the preliminary forecast of $228 million for the second quarter represents a sharp drop from the $305 million initially forecast, it could even jeopardize that target of $1.25 billion.

While this was a major disappointment for investors, it should be noted that the second quarter revenue projection would still represent a respectable 17.5% year-over-year growth. Of course, that’s a far cry from the triple-digit percentage growth that Upstart is used to.

On a more positive note, Upstart pointed out that all of its loan vintages between 2018 and 2021 work in its models. But as this is the first real economic downturn in which the company’s algorithm has operated, banks and investors are understandably a little worried about whether it will perform as well (or better) than traditional methods. credit reporting when we come out the other side.

It may take some time for the market to know how well Upstart’s newer loans are performing. Risk-averse investors may want to wait another quarter or two to see how it plays out.

Focus on the long term

Upstart currently operates in two key segments: unsecured loans and auto loans. Together, these markets are worth $863 billion a year, and as the company has only issued $25 billion in loans since its inception, this suggests it is still in the early stages of exploiting this opportunity.

But Upstart has identified business loans and mortgages as the next two segments it could potentially focus on. If he chooses to do so, his annual opportunity could reach $6 trillion.

Currently, 11 lenders have dropped minimum FICO score requirements in favor of Upstart’s algorithm. If the company successfully navigates this difficult time, it will likely attract many more banking partners and credit unions who are looking for a faster, more accurate alternative to FICO.

If you already own the stock, it might be best not to panic here. If you’re looking to buy it, now could be a good time given the stock is trading at a 93% discount from its all-time high. After all, the US economy may be about to enter less uncertain times.

Antoine Di Pizio has no position in the stocks mentioned. The Motley Fool holds positions and recommends Upstart Holdings, Inc. The Motley Fool recommends Fair Isaac. The Motley Fool has a disclosure policy.

Ruth R. Culp