Upstart: Bull against bear

The past year of trading has been brutal for financial technology (fintech) stocks, and few have had a tougher time than Upstart (UPDATE 0.46%). The company’s share price has fallen 91.5% in the last 12 months, and it is down approx. 97% from the top.

With macroeconomic challenges on the horizon potentially disrupting the company’s business model, is the formerly high-flying fintech down for the count? Or is this a case where market overreaction has opened the door for patient investors to see strong returns on a recovery? Read on to see why two Motley Fool contributors disagree on what’s next for Upstart stock.

Macroeconomic headwinds are testing Upstart’s business model

Parkev Tatevosian: My argument for Upstart stock centers around its unproven business strategy of processing loan applications with its proprietary model. It claims the model, infused with artificial intelligence (AI), is superior to older methods that use consumers’ credit scores to assess borrower quality. That may be true, but Upstart’s loan portfolio has yet to go through a downturn in the economy. This is when people tend to lose their jobs and default on loans more often.

Interestingly, Upstart aims to be a marketplace for borrowers and lenders to meet. Similar to a platform that eBay (EBAY -0.84%), the upstart wants to make money by bringing lenders and borrowers together without taking the risk of lending its own capital. The viability of this model is also in doubt as lenders, perhaps sensing an impending recession, have reduced funding loans on the platform. That has seen Upstart use its own capital to fund some customer loan requests, with management saying they’re only doing so because they see an opportunity to make big profits in the process.

The bank partners provided 188,519 loans in the last quarter, a decrease of 48% from the same quarter the previous year. That drop was partly to blame for Upstart’s revenue falling 31% in the quarter ended Sept. 30. With so much uncertainty, investors would be taking an outsized risk by investing in Upstart stocks. I think the potential reward is not worth enough to justify taking the big risk.

The bull case for upstarts

Keith Noonan: As my colleague Parkev notes above, Upstart hasn’t been through a serious financial downturn yet, and there are already signs that the business is struggling. The company held its IPO late in 2020 against a favorable backdrop of low interest rates. Now the macroeconomic tune has changed considerably, and investors are understandably unsure of what’s coming next.

It’s time for the fintech player, and the strength of the company’s much talked about, AI-powered loan matching model will be put to the test.

The appeal of Upstart is that their service can make getting a loan easier than it is through the traditional FICO scoring system from Fair Isaac. This allows the company to attract a wider, largely underserved customer base and offer more attractive prices. It’s an appealing goal, and Upstart says its AI-powered system has never been more accurate compared to a FICO-based loan origination model. But the market doesn’t seem to be buying it.

I think it’s fair to predict that Upstart’s business is in for more rocky performance in the near term, but the market may be undervaluing the company. Upstart has a total cash position of $830 million to work with, and it has some flexibility as long as losses don’t get out of hand at current levels. And instead of selling new stock to raise cash, Upstart has actually been buying back stock lately.

If Upstart can survive through economic downturn or an otherwise tough macroeconomic backdrop, the AI ​​and machine learning models should benefit from a wider range of data about what works and what doesn’t. It was inevitable that the company would have to persevere through tougher macro conditions at some point, and the business has some big challenges ahead. But Upstart’s stock has been pushed down to a level that leaves the door open for big upside if the company shows signs of life, and it could be worth a flyer for risk-tolerant investors.

Should Investors Buy Upstart Shares?

Despite a sharp decline in valuation, it would be a mistake to classify Upstart as a low-risk stock. The company faces some serious headwinds in the near term, and it has an uphill battle to prove its business model can endure through tough economic conditions.

On the other hand, it is possible that investors who take a contrarian, bullish position with the stock will see strong gains on some appreciation. There appear to be mounting challenges on the horizon, but big sales mean Upstart stock offers significant, massive return potential for risk-tolerant investors if the business can deliver moderate gains.