Upstart Holdings, Inc. (UPST), the artificial intelligence-powered fintech company, has been on a tear, skyrocketing by 71.1% in just three months. This impressive performance has outpaced both the broader tech sector and the S&P 500, leaving many investors wondering if they missed the boat or if there’s still room for the stock to climb higher.
Upstart’s recent success is closely tied to macroeconomic expectations surrounding the U.S. Federal Reserve’s interest rate policy. The company’s business model thrives when interest rates are low, as it primarily deals in personal and auto loans. Low rates make borrowing more affordable, boosting demand for loans and propelling Upstart’s growth.
Over the past few years, Upstart’s annual revenue run rate had halved from around $1 billion due to aggressive interest rate hikes implemented by the Fed to curb inflation. These rate increases had a significant impact on Upstart’s loan origination business, reducing demand across the board. However, the tide is turning.
The Fed, after a period of rate hikes, has signaled a shift in policy in recent months, sparking investor optimism about Upstart’s potential turnaround. The central bank lowered the benchmark interest rate by 50 basis points last week, and further cuts are anticipated by the end of 2024. This policy change is a major boost for Upstart, offering a lifeline to its business.
Upstart’s ability to build a strong institutional funding base has been critical to its recent turnaround. In the second quarter of 2024, the company locked in multiple long-term funding partnerships, reducing its reliance on its balance sheet to fund loans. During the second-quarter earnings call, CEO Dave Girouard emphasized that these internal improvements, driven by advancements in AI models and operational efficiency, have set the stage for Upstart’s comeback.
The recent 50-basis-point rate cut is a game-changer for Upstart. Its platform, which leverages AI to assess creditworthiness beyond the traditional FICO score, is poised to benefit significantly from falling interest rates. Upstart’s model is designed to capture a broader range of borrower profiles by using unconventional data points like education and employment history to predict credit risk.
In a high-interest rate environment, loan demand shrinks as borrowers either can’t afford or are hesitant to take on more debt. However, in a falling-rate environment, borrowing becomes cheaper and more attractive. This dynamic is crucial for Upstart, which has been working to regain its loan origination volume after years of declines due to high interest rates.
While Upstart’s revenue fell to $128 million in the second quarter of 2024, down from its previous highs, the Fed’s easing policies could help the company recover much of its lost business. If the Fed continues to lower rates as expected, Upstart could experience a surge in loan originations, leading to revenue growth. As the company’s lending platform attracts more borrowers, especially those previously priced out by high interest rates, Upstart’s market share is likely to expand further.
Upstart’s success isn’t solely reliant on interest rate movements. The company’s core strength lies in its innovative use of AI, enabling it to outperform traditional lenders like SoFi Technologies (SOFI) and LendingClub Corporation (LC). Upstart has enhanced its AI models over the past few years, automating the vast majority of its loan approval process. As of the second quarter of 2024, 91% of Upstart’s loans were fully automated, a significant efficiency boost compared to its peers. This level of automation allows Upstart to offer lower annual percentage rates (APRs) to riskier borrowers without compromising on credit performance.
In contrast, competitors like SoFi and LendingClub still rely heavily on traditional credit assessment methods, which can be less effective at accurately predicting default risk in non-prime borrowers. While SoFi has diversified into areas like banking and investing to mitigate the impact of interest rate fluctuations, it hasn’t achieved the same level of loan approval efficiency as Upstart.
Upstart’s AI capabilities empower it to expand its loan portfolio across multiple product lines. Beyond personal loans, the company has also made substantial progress in auto loans, home equity lines of credit (HELOCs), and small-dollar relief loans. Upstart’s move into these new markets provides additional revenue streams and solidifies its position as a comprehensive lending platform.
Despite the recent upswing, Upstart’s current valuation presents a compelling opportunity. The stock’s current forward 12-month price-to-sales (P/S) ratio indicates that it trades at a hefty discount to the Zacks Computers – IT Services industry average. At the closing price of $39.74 as of Sept. 20, UPST shares have been trading way below its all-time high of $390, indicating a strong upside potential.
The Zacks Consensus Estimate for Upstart projects strong growth in both revenue and earnings over the coming years, reinforcing the fundamental case for the stock’s continued rise. In the short term, any further interest rate cuts by the Fed are likely to serve as additional catalysts for Upstart’s growth.
Upstart’s 71% rally might make it seem like the stock is already fully valued, but its unique positioning in the fintech space suggests otherwise. The interest rate environment is becoming more favorable, and Upstart’s AI-driven platform gives it a significant competitive edge over traditional lenders. As borrowing costs fall, the company’s loan originations are poised to increase, driving revenue growth and profitability.
For growth-oriented investors, Upstart offers a compelling opportunity. Its focus on innovation, automation, and expanding access to credit positions it as a leader in the rapidly evolving fintech sector. With positive macroeconomic tailwinds and the company’s internal improvements, it’s clear that Upstart’s rally isn’t over yet. Now is the time to consider buying this stock while it’s still riding the wave of momentum and before it potentially reaches new highs.
