3 Big Reasons to Buy Upstart in 2022

Whether you're an investor or not, on some level you're probably familiar with the concept of artificial intelligence (AI). The technology has featured prominently in popular culture through movies (remember Will Smith's iRobot?) and other media, with many creative people offering their take on what it means for the future.

But there's a company using AI more covertly, and the algorithm it developed is rapidly becoming a popular way for banks to assess borrowers to originate loans.

Upstart Holdings (UPST -0.58%) listed in December 2020 at $20 per share. By October 2021 it reached a high of $401, delivering a return of 1,900%. But amid the recent tech sell-off, Upstart's stock has declined to $84 as of midday Monday. Here are three big reasons that's an opportunity right now.

Image source: Getty Images.

1. Artificial intelligence is a game-changer

Anyone in the U.S. who has borrowed money from an institution will have heard of the FICO credit scoring system -- after all, it's used in 90% of all credit decisions. The FICO score is designed to determine a potential borrower's creditworthiness by factoring in a handful of metrics, including payment history, existing debts, and the length of the individual's credit history. 

Upstart argues that FICO scores miss too much information, and that by using artificial intelligence, the company can quickly assess 1,600 data points to gain a better understanding of a borrower's ability to repay a loan. These expanded metrics might include a person's job history or where they went to school. This nuanced approach aims to be more inclusive for borrowers who don't fit the traditional mold, as the digital economy is far different from the one that existed when FICO scoring was introduced 30 years ago. 

The result, according to an internal study at Upstart, is 75% fewer defaults among Upstart-originated loans compared to those assessed the traditional way. And since Upstart's algorithm is AI-based, it also assesses much more quickly, with 67% of decisions being instant. 

2. Upstart is expanding into new verticals

It's important to remember that Upstart isn't a lender itself, and therefore it carries no credit risk. It uses its algorithm to originate loans for banks, and it also sells the technology to institutions that want to integrate it into their own application processes. One of Upstart's partner banks has even removed FICO scoring from its assessment process completely, in favor of the algorithm. 

Upstart first began by originating unsecured personal loans, but it recently expanded into automotive finance, its largest segment yet. For context, the company estimates the addressable market for automotive loan originations is $672 billion per year, about eight times larger than personal loans. 

Upstart's strategy is simple: target car dealerships as a source of originations. To achieve this, it acquired car-dealer sales platform Prodigy, then it redesigned the software to serve as both a sales and loan origination tool. The new iteration is known as Upstart Auto Retail, and it's blazing through the car industry.

Data source: Upstart. 

The company says it's adding an average of one new dealership per day, which means the 291 figure will more than double during 2022. But this isn't the end game. Eventually, Upstart could target the $4.5 trillion-per-year mortgage market, but it's still early days. 

3. Upstart's stock price is now attractive

At the beginning of 2021, Upstart told investors it expected to generate $500 million of revenue for the full year. It's yet to officially report its fourth-quarter 2021 result, but it appears to have generated over $800 million, a significant 60% beat. 

Analysts expect the company will deliver $1.2 billion of revenue in 2022, but with its automotive segment quickly ramping up, it could blow all estimates out of the water yet again this year. But more importantly, Upstart is profitable, and that's rare for a relatively young tech company. 

With $2.35 in estimated earnings per share for 2022, Upstart's stock trades at a forward price-to-earnings multiple of 36. While that's more expensive than the Nasdaq 100 index's forward multiple of 23, Upstart's rapid growth rate supports a premium.

Not to mention, its recent stock price around $84 is a steep discount to the $401 it traded at just a few months ago, and that's an opportunity. In five or even 10 years from now, the current price might look like a bargain, especially considering Wall Street investment bank CitiGroup recently attributed a $350 target to the stock.