Nasdaq Bear Market: 1 growth stock down more than 90% to buy now

The tech-heavy Nasdaq Compound fell 29% from its high, driven into a downward spiral by the deteriorating macroeconomic environment. But many individual stocks have fallen much further. A combination of weak forecasts, runaway inflation and rising interest rates has left Assets received (UPST 6.82%) 93% off its peak. But investors shouldn’t give up just yet.

Here’s what you need to keep in mind about this growth stock.

Upstart is on a mission to improve the lending industry

Upstart is a fintech company that aims to disrupt the credit industry. Its artificial intelligence-based platform captures far more data about potential borrowers than traditional credit models, theoretically allowing the company to quantify risk more accurately. Lenders benefit from lower fraud and loss rates, which can translate to high approval rates and lower interest rates from consumers.

As a caveat, Upstart’s AI models have not been tested during a significant downturn in the credit cycle, and the company recently downgraded its outlook for the second quarter, citing the macroeconomic climate. hard. Rising interest rates will likely dampen demand for loans, and high inflation will likely put pressure on consumers, making loan defaults more likely. These factors contributed to the sharp drop in Upstart’s share price.

However, investors still have reason to be optimistic. The chart below, compiled from Upstart research, shows annualized default rates for Just IsaacFICO-based underwriting versus Upstart-powered loans. At all thresholds, Upstart is able to quantify risk more accurately, separating cohorts of borrowers that FICO scores would otherwise group together. For example, borrowers with a FICO score of 639 or lower (considered low) but an A-plus rating from Upstart defaulted 1.2% of the time, while borrowers with a FICO score (high) of more 700 but an Upstart rating of E- minus failing 9.2% of the time.

Image source: Letter to Upstart Q1 2022 shareholders.

Unsurprisingly, Upstart’s perceived ability to more accurately quantify risk has translated into rapid growth. In the first quarter, the company had 57 banking partners on its platform, more than triple from the previous year. In turn, revenue soared 156% to $310 million in the first quarter, and net income soared 224% to $33 million.

On a less optimistic note, Upstart generated negative free cash flow in the quarter, largely due to the purchase of loans as part of the R&D it was conducting on its new auto loan program. For context, where banking partners are unable or unwilling to hold loans on their own balance sheets, Upstart may choose to fund those loans with its own cash, and that’s exactly what Upstart has decided to do over the course of the quarter – the company held close to $600 million. in loans at the end of the first quarter, more than double the $250 million it held in the fourth quarter. This spooked investors, as it exposes Upstart to significant credit risk.

Fortunately, Chief Financial Officer Sanjay Datta said the company would end this practice and Upstart has already taken steps to convert loans from its balance sheet to cash. Unfortunately, Upstart cited this conversion process as one of the reasons for the lower second-quarter guidance, meaning it likely sold the loans at a loss. All things considered, investors should be happy with the long-term implications of the decision, as it significantly reduces Upstart’s exposure to credit risk.

Where investors should focus

Going forward, investors should monitor the performance of loans funded by Upstart as the current macroeconomic environment continues to put pressure on consumers. Revenue and earnings growth are important, but Upstart’s value will ultimately be measured by its ability to price risk more accurately than traditional credit models. If the business can do this, revenue and profit growth will eventually take hold.

Here’s the gist: Upstart seems to have an advantage over FICO-based underwriting, and the company is growing rapidly. Even better, management pegs its total addressable market (TAM) at more than $860 billion, a figure that includes personal and auto loans. Upstart also plans to enter other vertical markets in the future, including the $640 billion small business lending market.

With stocks trading at a reasonable price of 2.6 times sales, I think risk-tolerant investors should consider buying a small position in this monster growth stock now.

Trevor Jennewin has no position in the stocks mentioned. The Motley Fool holds positions and recommends Upstart Holdings, Inc. The Motley Fool recommends Fair Isaac. The Motley Fool has a disclosure policy.

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