Down 45% Despite Great Earnings, Is Upstart a Buy?

Lending technology company Upstart (UPST -0.58%) has been a phenomenal performer since its 2020 IPO, but recently pulled back after its third-quarter earnings report. In this Fool Live video clip, recorded on Nov. 11, Fool.com contributors Matt Frankel, Trevor Jennewine, and Jason Hall discuss whether this could be a buying opportunity in the high-flying stock. 

Trevor Jennewine: Upstart, another FinTech company. I'm sure a lot of Fools are familiar, like Matt said, but Upstart uses artificial intelligence to improve access to consumer credit. It captures a lot more data than traditional credit models consider, and that essentially allows it, or theoretically allows it to quantify risk more precisely. Management mentioned that they think its platform is 4-8 times more accurate than traditional credit models.

The stock got hit very hard after earnings fell about 25%, I'd say. I think it's down again today. Let's take a look. In Q3, revenue was $228 million, that was up 250%. The transaction volume originated on its platform was $3.1 billion, up 244%. The company's profitable on a GAAP basis. The profit was $0.30 per diluted share up 200%. One concern operating income rose 134%, so their operating income is growing more slowly than revenue, and that is similar to SoFi (SOFI -0.42%) due to rising expenses, especially in sales and marketing and research and development, those lines are growing particularly quickly.

On the bright side, Upstart over the last year, they've tripled the number of banks and credit unions on their platform. As of September 30th, 2020, they had 10 bank partners. They've got over 30 today, and the CEO recently said that he would be surprised if in a couple of years they didn't have hundreds on the platform. I think that's a good trajectory. There's also seven bank partners that are using its platform for auto loans now, and they have 291 dealerships that they're working with, and management mentioned they're adding about one new dealership every day.

Upstart started with personal loans. They've expanded into auto loans. Those two industries collectively, the market opportunity is about $750 billion in the U.S. I like the way that they're growing their business. Taking a look at Q4, they're expecting revenue of about $260 million at the midpoint. That would be up about 200%. Net income, they're looking for $18 million at the midpoint, and that would be a sequential dip, still way up on a year over year basis. But I think the growing expenses and the dip in Q4 net income were the worst parts of the earning, and the stock was up so much.

I think a pullback was almost inevitable, but all things considered, I think the company is making good progress. This looks like a relatively strong quarter. With that, $750 billion market opportunity, if you annualize the loan volume originated on its platform, Upstart's captured about just over one percent of that. Plenty of room to grow the business, and management has mentioned going into other areas like credit cards and student loans, mortgages, and addressing the $4.5 trillion consumer lending industry more broadly. Again, similar to Latch, this pullback looks like maybe a good opportunity to buy a few shares. I could certainly see this company growing 10X from here.

Jason Hall: It's crazy, Matt. Just thinking about the scalability of this business, and what it's done. The stock is already like an eight-and-a-half bagger. It's up over 500% this year, and that's even with taking a giant haircut post earnings. I just want to say one thing and I'd love to hear your thoughts, and then I'll shut up since we're getting close to the end here.

My concern with Upstart is the same concern I have with a lot of FinTech start-ups that are involved in lending, they're doing things differently. We haven't gone through a full credit cycle. We don't really know if what they're doing is really truly better. Is it the same quality that we see from other high quality lenders? We don't know, and we won't know until there's an economic downturn, until there's something that changes in the credit cycle. That's my biggest concern with Upstart, and it's going to be that way for maybe a few years, five years maybe before we see a turn on the credit cycle. I'm just curious to hear what you guys think there.

Matt Frankel: I think this was a case where anything less than perfection was going to make the stock go down just because of how well it did. One thing that I did notice in their earnings that could potentially have disappointed investors, the company's full-year revenue guidance had been raised so dramatically over the past few quarters. It was raised from $500 million to $750 million. A raise of 50% over the course of two quarters for the full year guidance. This quarter, the full year guidance was raised by, I think it works out to roughly 7%, if I'm doing the math correctly.

It was a single digit raise in the guidance, which in any other company, raising your guidance by 7% would be a big positive catalyst, but it's just not what the company had been delivering for the past few quarters. I think the market saw that as an imperfection in the earnings report. There really wasn't anything to be disappointed in. Like Jason said, it had run so far. It actually had 15Xed from its IPO before this, which was in December, not even a full year.