This Cheap Stock Is Down 94%: Is It a No-Brainer Investment Opportunity?

Upstart (UPST 1.81%) has taken its longtime shareholders for a wild ride. After shares skyrocketed 1,220% from their initial public offering in December 2020 to their all-time high in October 2021, they have cratered 94% since (as of May 23).

The pessimism with this fintech stock has likely never been higher; it has dropped 43% just this year. Investors who have an appetite for risk, with the potential for achieving high returns, might be eyeing Upstart as a possible portfolio addition.

Is this a no-brainer investment opportunity right now?

Influenced by macro forces

With the artificial intelligence (AI) boom in full swing, many investors are trying to gain exposure to this tech trend. To its credit, Upstart has been working on utilizing AI and machine learning capabilities to better analyze consumers’ creditworthiness since its founding more than a decade ago. The company believes it can disrupt the traditional FICO scoring method, which only looks at five different factors. Upstart considers more than 1,600 variables before making a lending decision.

For the more than 100 banks and credit unions that partner with Upstart, this could, in theory, lead to greater revenue potential. Being able to target a large potential customer base, while at the same time managing default risk, is a compelling proposition.

However, this business has proven to be extremely cyclical, struggling mightily in a higher-rate environment. The last couple years haven’t been the best for Upstart, to put it kindly.

In 2023, the company reported a loan volume decline of 59%. This was in stark contrast to the 338% gain posted in 2021, when interest rates were much lower. Upstart’s revenue reflected this disappointing new trend.

Think about things from the consumer’s perspective: If interest rates are high, monthly payments will be high as well, and this discourages people from wanting to take out loans.

Besides investors souring on speculative growth tech stocks, Upstart’s poor fundamental performance helps explain why shares have gotten crushed. As of this writing, they trade at a price-to-sales ratio of 3.7, which is significantly below their historical average.

Risk and uncertainty

Despite its cheap valuation, I still view Upstart as a very risky stock to own. Apart from its choppy revenue figures, the business is burning through cash. In the past five quarters, Upstart reported $305 million in cumulative net losses. There’s really no telling when this trend will end.

Upstart’s supporters might argue that now is a good time to buy the stock, with the anticipation that the Federal Reserve will lower interest rates in the not-too-distant future. In this scenario of looser monetary policy, there could be stronger demand for loans from borrowers. Then Upstart might be able to return to the monster growth and impressive profitability it registered back in 2021.

That sounds like a smart strategy, but this requires you to be able to correctly predict the direction of macroeconomic factors. No one, not even the Federal Reserve, knows when inflation will subside and when rates will start to come down. What if the U.S. remains in a higher-rate environment for longer than expected? That would probably lead to a disappointing outcome.

Investors should wait until Upstart can report consistent revenue growth and positive earnings over a full economic cycle before considering buying shares. But it’s anyone’s guess when this might occur (or if this will even happen).

At the end of the day, a good guideline is to avoid owning businesses that depend so heavily on favorable macro conditions for their success. Upstart hasn’t shown that it doesn’t belong in this category of companies.