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

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

Reached (NASDAQ: UPST) took its long-time shareholders on a wild ride. After shares soared 1,220% from their IPO in December 2020 to their all-time high in October 2021, they have fallen 94% since then (as of May 23).

Pessimism with that fintech stocks has probably never been higher; it fell 43% this year alone. Investors who have an appetite for risk and potential for high returns might consider Upstart as a possible addition to their portfolio.

Is this an obvious investment opportunity right now?

Influenced by macro forces

With the artificial intelligence (AI) is in full swing, many investors are trying to gain exposure to this technological trend. To its credit, Upstart has been working on using AI and machine learning capabilities to better analyze consumer creditworthiness since its inception over a decade ago. The company believes it can disrupt the traditional FICO scoring method, which only considers five different factors. Upstart considers over 1,600 variables before making a lending decision.

For Upstart’s more than 100 partner banks and credit unions, this could, in theory, lead to greater revenue potential. Being able to target a broad base of potential customers, while managing default risk, is a compelling proposition.

However, this sector has proven to be extremely cyclical and is experiencing significant difficulty in a higher interest rate environment. The last two years haven’t been the best for Upstart, to put it kindly.

In 2023, the company reported a 59% drop in loan volume. This stands in stark contrast to the 338% gain seen in 2021, when interest rates were much lower. Upstart’s revenue reflects this disappointing new trend.

Think about it from the consumer’s point of view: if interest rates are high, monthly payments will be high, which discourages people from wanting to take out a loan.

Besides investors flocking to speculative growth tech stocks, Upstart’s poor fundamental performance helps explain why the shares have been crushed. As of this writing, they are trading at a price-to-sales ratio of 3.7, which is significantly lower than their historical average.

Risk and uncertainty

Despite its cheap valuation, I still consider Upstart a very risky stock to own. In addition to its unstable revenue numbers, the company is burning through cash. Over the past five quarters, Upstart reported $305 million in cumulative net losses. We really don’t know when this trend will end.

Proponents of Upstart might argue that now is a good time to buy stocks, with the expectation that the Federal Reserve will lower interest rates in the not too distant future. In this looser monetary policy scenario, demand for loans from borrowers could be stronger. Upstart might then be able to return to the monstrous growth and impressive profitability it recorded in 2021.

This seems like a smart strategy, but it requires you to be able to correctly predict the direction of macroeconomic factors. No one, not even the Federal Reserve, knows when inflation will ease and when rates will begin to fall. What if the United States remains in a higher interest rate environment longer than expected? This would likely 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 no one knows when that might happen (or even if it will).

Ultimately, a good guideline is to avoid owning businesses whose success depends heavily on favorable macroeconomic conditions. Upstart has not demonstrated that it does not belong to this category of companies.

Should you invest $1,000 in Upstart right now?

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Neil Patel and its clients have no position in any of the stocks mentioned. The Motley Fool posts and recommends Upstart. The Mad Motley has a disclosure policy.

This Cheap Stock Is Down 94%: Is This an Obvious Investment Opportunity? was originally published by The Motley Fool

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