Upstart Holdings, Inc. (UPST), which operates an AI lending platform in the U.S., came under pressure when the Fed started hiking interest rates in 2022 to fight inflation. However, Upstart stock is ready for a resurgence aided by improving macroeconomic conditions. Despite rising 78% this year to around $73, UPST stock is still a long way away from the highs of close to $400 touched in 2021 before crashing. I am bullish on Upstart as I believe the company’s AI model enhancements, diversification into new lending markets, and expansionary monetary policy decisions by the Fed will boost earnings growth.
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Upstart’s AI Model Enhancements Are Impressive
One of the main reasons behind my bullish stance on Upstart is the company’s continued investments in improving its AI algorithms. These model enhancements are likely to result in higher automated loan approvals, lower credit default events, and higher conversion rates. As part of model enhancements, Upstart launched Model 18, the company’s latest and most advanced personal loan underwriting model, in August. This revamped model helps Upstart select creditworthy borrowers by using more streamlined loan affordability and adverse selection criteria, resulting in lower credit risk for partner banks.
In addition to this, Upstart has enhanced its predictive models using millions of repayment data recorded in the last four years to improve the accuracy of its macroeconomic risk assessment framework. Speaking with American Banker last September, Upstart CEO Dave Girouard detailed how the company remains focused on upgrading its models to predict macroeconomic events better in the long term, mitigating the risks associated with unforeseen credit events. For context, Upstart failed to accurately estimate the risk of high interest rates in 2022, forcing the company to keep loans on its balance sheet and expose shareholders to increased credit risk.
Another major model improvement is the launch of Parallel Timing Curve Calibration, a patent-pending technology that enables faster evaluation of predictive model performance across the full tenure of a loan and reduces the feedback loop from three years to just one month. This advanced technology will help Upstart in several ways, including improved model accuracy, enhanced risk assessment capabilities, and increased investor confidence in the company’s ability to weather an economic downturn.
Upstart’s Diversification Efforts Open New Doors to Grow
In addition to AI investments, I am impressed by Upstart’s focus on diversifying into new markets that offer plenty of growth opportunities. The company is aggressively expanding into home equity loans, which, according to the company, is a $1.4 trillion market. In Q3 2024, the company approved 283 home equity loans with a value of $17 million, more than double the $8 million in home equity loans approved in the previous quarter.
Upstart’s auto financing business is also gaining traction. Auto loan originations grew 46% sequentially to $26.5 million in Q3, with the company signing its 11th digital retailing OEM agreement in October. The company is also expanding into small business loans.
Macroeconomic Conditions Are Improving
My bullish stance on Upstart has been strengthened by the improving macroeconomic climate, which supports lending platforms. The Fed turned dovish in September, delivering the first rate cut in this cycle. According to economists polled by Reuters, the Fed will deliver two rate cuts of 50 basis points in the first two quarters of 2025 and another 25-basis point rate cut in the fourth quarter, bringing the Fed funds rate to a range of 3% to 3.25%.
These rate cuts are likely to improve the affordability of loans, resulting in a surge in the demand for both personal and auto loans. In return, this demand may help Upstart see increased loan originations on its platform.
Lower interest rates and increased demand for loans should also encourage more lending institutions, such as banks and financial services companies, to sign up as lending partners on Upstart’s platform, paving the way for the company to address the borrowing needs of a larger customer base.
Is UPST Stock a Buy, According to Wall Street Analysts?
Despite the improving prospects for Upstart and the third-party lending sector, some Wall Street analysts are spooked by the company’s expensive valuation. For instance, JPMorgan analyst Reginald Smith downgraded Upstart on December 2, citing concerns about the forward P/S (price-to-sales) ratio of 9x which, according to the analyst, accounts for the expected growth in the next 12 months.
Based on the ratings of 14 Wall Street analysts, the average Upstart Holdings price target is $31.44, which implies a downside risk of about 57% from the current market price.
Although analyst estimates reveal a Moderate Sell rating for Upstart, I believe the company is well-positioned to experience robust earnings growth in the next few years, potentially leading to higher stock prices. At a forward P/S of just over 10x, Upstart is not cheaply valued but analysts believe revenue will grow in double digits in each of the next five years. With Upstart’s contribution margin showing early signs of improvement in Q3, I believe stellar revenue growth will once again push the company into profitability, similar to how it did in 2021.
Takeaway
After suffering from rising interest rates since 2022, Upstart Holdings is making a strong comeback with interest rates beginning to decline. The company’s strategic investments in improving its predictive AI models are likely to deliver handsome returns in the long term when macroeconomic conditions turn for the better, supporting the lending sector. Although Upstart is not cheaply valued, I believe investing in this young company with disruptive potential may lead to lucrative long-term returns.
