DISCLOSURE: I own a tiny bit of Upstart, even though I no longer actively invest.
Call it a hobby. Like HO trains in the basement or a twinkie in the city. My investment
in Upstart is money I can afford to lose. A 100% permanent loss here wouldn’t affect my
retirement or other financial goals one bit. In other words, heads I win, tails I scrape
my elbow, but don’t get killed.
This is Part 1 of a 594-part series on Upstart. In this first part, we’ll look at what
the current share price is telling us about investor expectations for Upstart’s future
performance. We’ll do that by developing a model to monitor those expectations.
To get started, we’ll gather some information to help us answer three questions:
- How much cash can Upstart’s business generate for us?
- When will we get that cash?
- How certain are we that we’ll actually get that cash?
Here’s the data I used to start the model:
Estimated Sales FY2021 $804M <= Midpoint of guidance
Estimated Operating Margin 15% <= My estimate, based on trend
Estimated fixed capital investment rate 6% <= ditto
Estimated working capital investment rate 10% <= ditto
Tax rate 15% <= Blended rate over multiple years (my estimate)
Inflation rate 2% <= My estimate
Share price 1/7/2022 $116.95 <= From Yahoo
Diluted shares 12/31/2021 96.7M <= From Upstart guidance
Market Value of Equity $11.4B <= Price * shares
Cash and Securities $1,172M <= From 9/30/2021 Balance Sheet
Debt $806M <= ditto
The measures above kick off the effort to answer the first question: how much cash can
Upstart’s business generate for us? It does this by looking at beginning sales, profit
margins, investments in fixed and working capital, tax and inflation rates, and the value
of non-operating assets and debt. At the end of the day, we’re looking for how much cash
the business can give back to us, the owners, after meeting all its operating and
capital allocation objectives.
To answer the second and third questions, we need two more measures: the sales growth
rate and the cost of capital. Both of these are situational and speculative. Rather than
try to guess them, we look at a range of values for them. Each set of values will tell
us something about investor expectations implied by the current price.
Here are some examples, given the starting inputs to the model:
Example A.
We think Upstart’s cash flows are highly risky so we peg cost of capital at 20%. The
implied forecast period – when we’ll recoup our $116 share price – is 11 years with
a 50% annualized sales growth rate and 23 years with a 25% annualized sales growth rate.
Example B.
We think Upstart’s cash flows are moderately risky so we peg cost of capital at 15%. The
implied forecast period – when we’ll recoup our $116 share price – is 9 years with
a 50% annualized sales growth rate and 21 years with a 25% annualized sales growth rate.
Example C.
We think Upstart’s cash flows are run-of-the-mill risky so we peg cost of capital at 10%.
The implied forecast period – when we’ll recoup our $116 share price – is 6 years with
a 50% annualized sales growth rate and 15 years with a 25% annualized sales growth rate.
In all examples, we look to see if the implied growth rates look reasonable to us. (Keep
in mind the beginning inputs to the model are also just estimates and can distort our findings.
They almost certainly will be upgraded as we get more information in future reporting periods.)
Important! => We are not building the James Webb Telescope here. We’re not aiming for
precision. Instead, we’re using very rough estimates based on our current knowledge of
the business. We’ll refine these estimates as we get more information about the business
in the coming years. Upstart has a limited operating history and many unknowns so many
of these measures are uncertain. Our goal, however, is quite modest. We’re developing a
tool that we can use to help us better understand and monitor business drivers, not to precisely
forecast business performance.
I’m in the camp that believes Upstart is extraordinary high risk. Binary. Can easily go to
zero or hero. Therefore I give it a high cost of capital which means it needs an extraordinary
growth rate to justify the current price in any reasonable time frame. Right now I think the
market has the price about right, with no margin of safety.
Of course, Morningstar has just assigned it a fair value of $228, albeit with “extreme
uncertainty”. Extreme uncertainty to me means high cost of capital – in the 25%
range. Given Morningstar’s target of $228, that translates to an implied forecast
period of 14 years with an annualized growth rate of 50% and greater than 25 years with
an annualized growth rate of 25%. Quite the hurdle.
Meanwhile, I’m looking forward to Upstart’s year-end results in March. That should provide
valuable corrections to the model. Either that or you can find me in the basement with my
trains.
Choo choo!
Ears