Thanks to the Federal Reserve’s aggressive interest rate increases in 2022, the stock market tanked that year. However, last year brought with it a new sense of hope as the S&P 500 soared 24%.
Growth tech businesses were some of the best-performing in the market. Just look at Upstart (UPST 1.24%), whose shares more than tripled in 2023.
This fintech stock benefited from strong market sentiment. But before you jump in and buy shares, you need to understand a major risk factor.
Cause for concern
As of this writing, Upstart shares remain 92% below their all-time high, which was set in October 2021. To say that the company has been struggling in a less accommodating economic environment would be an extremely accurate statement.
Upstart has developed a proprietary artificial intelligence (AI)-based lending tool that its more than 100 partners can use to approve borrowers. When interest rates were low, demand for the service was high. But during the past couple of years, the opposite has been true. And Upstart has paid the price.
The big risk that investors can’t ignore is that this is a cyclical company, which is not what many bullish supporters had expected.
In 2022, Upstart’s revenue decreased by 1%, a huge contrast from the 264% growth posted in 2021. Last year, things got even worse. Revenue fell off a cliff, down almost 50% through the first nine months of 2023. And in the third quarter, the business reported that transaction volume declined 34% on a year-over-year basis.
To be clear, many companies out there are cyclical. When the economy turns or when the Fed starts tightening monetary policy, it creates an unfavorable environment for growth. That’s understandable.
What makes matters worse for Upstart, though, is that it hasn’t proven it can be consistently profitable. It produced $135 million in net income in 2021, but that was during boom times. The business reported a net loss of $109 million in 2022 and $198 million through the first three quarters of 2023. This calls into question Upstart’s long-term viability as a sustainable business.
It’s hard to want to own a company that depends so heavily on external factors to go in its favor. However, some investors might still be drawn to Upstart and its disruptive potential.
The company does have some things going for it. It has long been working on AI initiatives before this technology was a hot buzzword. Even better, Upstart has already found real-world adoption with its AI lending platform. That’s admirable.
Thanks to the analysis of 1,600 different variables, compared to the five key factors that the FICO model looks at, Upstart has shown that it can more accurately assess credit risk. The result is access to a larger customer base for Upstart’s lending partners, as well as greater access to credit for borrowers who might be declined for loans through traditional channels.
While there might be limits to how much of the $4 trillion total addressable lending market that Upstart can penetrate, it’s definitely encouraging to see the business operate in such a huge industry that includes personal, auto, small business, and home loans. Any way you slice it, annual lending volume in the U.S. is a gargantuan sum.
There might be enormous potential for Upstart over the very long term. However, I view the previously mentioned risk of the company’s cyclicality as a compelling reason to stay away from the stock right now.
Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Upstart. The Motley Fool has a disclosure policy.