I have been thinking hard on whether to add back UPST to my portfolio. I sold everything after hours on Q3 report in Nov, bought back a 15% sized position the next day, but then sold it all again in the first week of Dec to reallocate to stronger SaaS companies that fell (DDOG primarily).
Now in January, its price has fallen another 40% from when I last sold.
However, I finalized my decision to not get back into UPST for now.
If my portfolio is to comprise only the truly best of breed hypergrowth stocks by “following the numbers”, UPST just can’t fit back in today.
In other words, I must not conflate reward/risk ratio with the probability of the desired outcome panning out.
Risk reward ratio: UPST share price drop, all else being equal, means greater potential returns if I buy it today.
Desired business outcome probability: the chance of auto succeeding in 2022, however, has NOT changed, just because the stock price has changed!
Why does auto matter so much? Because personal loan growth may not sustain in 2022.
UPST already commands at least 20-30% of the below-prime personal loan market.
Those are the core borrowers and its truly near term obtainable market share. While UPST is trying to expand to the super prime/above prime category, I don’t think that’s going to be anywhere near as fast growing as its current hold on the below prime market in the near future.
Recall from the October 2021 publication: https://www.hbs.edu/ris/Publication%20Files/22-024_80dc9115-…
“Our dataset begins in 2014 and ends in the first quarter of 2021… On average, Upstart’s loans are about $11,700. The standard deviation of $10,000 indicates significant heterogeneity among borrowers, some individuals borrowing significantly larger amounts. The average contract is characterized by an APR of 22% with a four-year maturity. Borrowers tend to have an average credit score of 653 at origination. That even the top quartile exhibits a score barely above 680 shows Upstart’s focus to be on other than the individuals traditionally regarded as most creditworthy.”
UPST has already originated $7.654 billion from Q1-Q3 2021. In Q4, I expect them to originate at least $4B. So in total, $11.654 billion in 2021.
The 2021 personal loan originations market size might be $100B. But the below prime segment is about 40% of the total market.
At 11.654B / 40B, then UPST holds 29% of the 2021 below prime market. But, let’s suppose UPST keeps a 4B origination volume each quarter this year. Let’s assume the total market expands to 110B in 2022, and the below prime market to 44B. Then, that’s 16B / 44B = 36% market share in 2022 at the expected Q4 run rate.
That just does NOT leave a lot of room for sustained hypergrowth in 2022 by personal loans alone!
For example, if we estimate they grow personal loans at, say, 15% QoQ throughout 2022, starting from 4.0B in Q4 2021, that yields 4.6B + 5.29B + 6.08B + 7B = about 23B in personal loan originations in 2022. That would be a 98% YoY increase in origination volume from 2021. Is that possible? yes, but unlikely - this is hope! The law of large numbers will probably play a role in significantly decelerating personal loan growth.
And that’s why auto absolutely has to take off in 2022. But we know this is a wildcard. And that the preliminary numbers are not currently supporting the case that it will grow fast enough to replace a slowing personal loan volume growth. As I’ve said before, autorefi numbers have been very disappointing so far. Again, they expanded autorefi availability to 47 states in Q2. But in Q3 they could only complete 2000 autorefi loans…that’s pocket change numbers and in my opinion, very very slow growth from a nearly nonexistent base of 2000 autorefi loans completed in the first 6 months of 2021!
Maybe in Q4 2021, we’ll see numbers that show the contrary but - this is hope.
Similarly, success of auto retail/Prodigy platform is hope right now. We have no numbers to go on, other than the first loan was made on the platform in October 2021.
2.) Macro - covid/inflation
Other than auto, we also have two other major factors at play.
Omicron/COVID might have outsized impact on the personal loan market, or at least, cause management to use it as an excuse to not provide strong 2022 guidance when they report Q4 numbers. We can hope that doesn’t happen, but as we have seen with LIGHTSPEED last year, these macro events can have disturbingly outsized surprise impacts on consumer facing businesses.
And let’s not forget, inflation can have surprise impacts on spending (and thus, negative impact on personal loan demand). We saw yesterday that “U.S. retail sales slide the most in 10 months. December drop of 1.9% well worse than projected 0.1% decline. Decrease was broad with 10 of 13 major categories weakening.”
(As an aside, I suspect news like this will also create as much uncertainty for other stocks like AFRM).
3.) Macro - loan sizes
Loan sizes might not rebound or stabilize in 2022. If we follow the numbers, this is a disturbing trend with no evidence of recovery so far.
Q4-20 Q1-21 Q2-21 Q3-21 Loan size $10122 $10186 $9743 **$8628**
So if we believe loan sizes will bounce back in 2022 - this is also entirely based upon hope.
Now, I want to emphasize that feeling uncertain about the outcome does not guarantee UPST will fail. I’m rooting for the company. In fact, I’m currently estimating they will do 491K loans in Q4. And it’s still very early, but at the current run rate of Trustpilot reviews, they might do 554K loans in Q1 2022. But what we actually know from the Q3 report projects a murky future for 2022.
UPST might be a good ‘trade’ at current prices (I have played with small amounts of call options as a ‘bounce from oversold’ play last month), but holding shares with the same long term intent as DDOG or ZS seems not to be the best fit for my portfolio with all the information we have at hand today. Remember, DDOG or ZS or SNOW are not really going to be impacted by Omicron, inflation - and crucially - have reliably certain and expanding recurring revenue (DBNRR).
As I said at the top of this post, I don’t want to confuse a share price’s “risk vs reward” (it’s improved for UPST) with the fundamental “business outcome probability” (it hasn’t improved for UPST since Q3 report, and that probability of 2022 success decreased from Q2 to Q3).
Put another way. While we are always, in a sense, picking a story for our portfolio stocks…we have to decide, are we choosing the story of ‘fighting the market’, or ‘fighting the numbers at hand’?
In UPST’s case, if we buy shares today, are we disagreeing with the market dropping the share price of our company for ‘no reason’…or are we disagreeing with the hints provided by the latest earnings report and conference call numbers (that is, investing based upon hope).
A comment on MNDY
It’s like with MNDY - its stock price has been relatively hit much harder compared to DDOG, ZS, SNOW versus its remarkable hypergrowth rates. Why? I believe the market thinks growth durability for MNDY is far lower than DDOG, ZS, SNOW due to intense competition in the space.
However, in this case, I’m ‘fighting the market’ - not ‘fighting the numbers.’
MNDY earnings have been flawless thus far and I won’t sell unless that changes in future earnings reports.
In this case, MNDY’s last earnings numbers actually increased the chance of a positive ‘business outcome’ AND the risk reward ratio has increased as well due to the share price falling. So it makes sense to keep my existing (tax deferred account) MNDY shares, and I plan to add back to my taxable account (when my tax loss wash sales go away in a few days).