Upstart Holdings (UPST) shares have soared 711.5% in 2021, having a 52-week range of $22.61-$401.49.
This artificial intelligence-powered lending platform is disrupting the way consumers get loans, and how banks provide loans. Upstart Holdings operates a cloud-based AI-lending platform.
I am bearish on the stock. (See today’s best-performing stocks on TipRanks)
Earnings
Upstart delivered a very strong second-quarter earnings report, and raised its FY 2021 guidance well above the analyst expectations.
Upstart reported revenues that increased 1,018% year-over-year to $194 million, beating the consensus estimates of $157.8 million.
What was the key driver for this revenue increase? It was attributed to growth in fee revenues, which increased 1,308% to $187 million. Upstart revised its guidance for fiscal 2021 upwards, estimating revenues of $750 million, versus the previous estimate of $600 million.
This seems like an ideal scenario for a company, beating the estimates for the quarter and signaling further revenue growth expected.
Valuation: Too Rich, too High, too Fast
Assuming the $750 million revenue is achieved by end of 2021, then if the stock stays at its current price and market capitalization remains unchanged, then Upstart Holdings will be trading at 37x its revenue.
This is too high, making the stock very pricey now, something that analysts have already noticed having an average price for UPST stock at $297, implying a downside of 16.9% from the current stock price.
Bank of America (BAC) analyst Nat Schindler downgraded Upstart Holdings stock mentioning “while we see Upstart’s significantly higher growth rate vs. industry and Upstart papers trading at a premium as proof of Upstart’s differentiated ability to price risk, we think the current market valuation at 24X our 23E sales leaves little room for upside.”
Compare also the P/E Ratio (TTM) of 510.4 for UPST stock with the current PE ratio of S&P 500 at 28.8 and you get an idea that on a relative valuation this AI lending stock is significantly overvalued.
Is AI Flawless?
Upstart Holdings relies on its proprietary use and development of artificial intelligence to generate more revenue by providing a link between borrowers and lenders.
This AI predicts, analyzes, and makes decisions, and at the end consumers get loans, and banks continue to do their business of lending capital.
What if there is a loophole in this AI use? After all, AI is not error-free. It is supposed to minimize human errors.
There are notable costs associated with the constant development of AI. Implementation costs, such as research and development, a lack of creativity, a performance that is based on the quality of inputs, and although AI can be more effective in managing tasks compared to humans, nothing can replace experience and human logic.
The 2008 subprime mortgage crisis was due to the low-quality screening of banks related to the due diligence of the creditworthiness of their clients. It was too easy to get a mortgage loan, and the financial crisis that resulted was a very expensive lesson learned for the global economy.
As the Fed is preparing to taper its bond-buying program gradually, interest rates will eventually rise. Lending money will inevitably become more expensive.
In the scenario that interest rates increase sooner than expected, then AI has to adapt to new situations, and re-assess the credit score and creditworthiness of customers. This means more operating expenses for Upstart Holdings, as it will have to invest more in refining and updating its AI technology.
Weak Operating and Net Margins
As investors have sent UPST stock soaring in 2021, it is notable to mention that the operating and net margins are weak. In FY 2020 Upstart Holdings reported operating income of $11.8 million on total revenue of $233.4 million or 5%. The net margin was 2.6%. There was also a stock dilution in 2020 due to the IPO and exercise of common stock warrants.
It seems that Upstart Holdings is operating now in the hyper-growth stage of revenue. It is too early, with less than a full year of going public, to get too excited as the profitability and free cash flows have yet to show a desirable consistency.
The Q3 2021 results due on November 9 will provide more guidance. For now, UPST stock is very disconnected from its intrinsic value.
Wall Street’s Take
Turning to Wall Street, Upstart Holdings has a Moderate Buy consensus rating, based on four Buys, one Hold, and one Sell assigned in the last three months. The average Upstart Holdings price target implies 16.9% downside potential.
Disclosure: At the time of publication, Stavros Georgiadis, CFA did not have a position in any of the securities mentioned in this article.
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