I am such a believer in Upstart I have gotten absolutely crushed since their Nov. 9 earnings, when it was about a 40% position for me. I sold a bunch in the mid 200s but then bought a lot of it back in the mid-100s. But I am concerned the wholesale selloff of our stocks is not the only reason Upstart is selling off. Or, to put it differently, I think that while the reason is very similar (fears–unwarranted, in my view–that inflation will eat away at the earnings power of our companies) Upstart is more of a risk in a rising or volatile interest rate environment.
To quote from their 10-K, Upstart’s AI models
“may not be able to effectively account for matters that are inherently difficult to predict and beyond our control, such as macroeconomic conditions, credit market volatility and interest rate fluctuations, which often involve complex interactions between a number of dependent and independent variables and factors. Material errors or inaccuracies in such AI models could lead us to make inaccurate or sub-optimal operational or strategic decisions, which could adversely affect our business, financial condition and results of operations.”
I am pretty confident that Upstart can ride this out and make any necessary adjustments to its models in the long run, but not confident enough to keep it as my number one position. So, painful, though it was, I sold a third of my Upstart shares at 119 and put the proceeds into DDOG (now number one) and SNOW.
I am pretty confident that Upstart can ride this out and make any necessary adjustments to its models in the long run, but not confident enough to keep it as my number one position. So, painful, though it was, I sold a third of my Upstart shares at 119 and put the proceeds into DDOG (now number one) and SNOW.
I welcome debate over my decision.
Hi philiproth, since you asked for comments, I’d have to say that your decision makes absolute sense. I agree that having UPST as your largest position is too risky, and see nothing wrong with the companies you moved the money too. My only caveats are one, you should have done it sooner, and two, you picked the two companies that have declined the least from their highs (DDOG and SNOW), as of yesterday’s close. Maybe that was intentional, looking for strength, but there are some that are down lots more for no reason.
To my mind, the UPST is a kind of umbrella safeguard statement to ensure they have cited every conceivable risk there is, short of the sky falling down, to protect them against litigation. If you read any company’s 10-K, there is always an endless litany of that sort of caveats.
The past two years of Covid pandemic have been unprecedented and as such much harder to model and predict than interest rate fluctuations (for which we have hundreds of years of history to compare to after all). They apparently had no problems dealing with that, so I am much less concerned about their model’s ability to deal with plain normal macroeconomic changes.
But I think we all agree that a 40% allocation is too high for any single position, no matter which or when.
luciuse, I agree with your sky falling down point. This warning is largely just boilerplate. But we haven’t had inflation or a sustained rising rate environment for a very long time, and while it has happened in the past, the world and the markets were very different. (No algorithmic trading, for example.)
But my main point is that interest rate moves will affect Upstart’s business in ways that they aren’t likely to affect our other companies.
For example, if rates are higher, might loan volumes decline? Maybe higher rates will drive more customers to Upstart since their rates will be lower than competitors. But, as I say, a bit of a wild card. I do think there is a very real chance UPST will far outpace our other companies if it can show consistent earnings and sales growth. And unlike the SaaS companies, I actually understand what it does, how desperate a need there is to replace the FICO score, and how inefficient banks are when it comes to lending.
you picked the two companies that have declined the least from their highs (DDOG and SNOW), as of yesterday’s close. Maybe that was intentional, looking for strength, but there are some that are down lots more for no reason.
This is a form of ‘anchoring’ which can be problematic when making investing decisions. What should be recommended is anchoring on value. What are the companies worth (or what are their future earnings) and then determining what investments make the most sense from that.
interest rate increase is widely seen as positive for banks and financial institutions… it enables them to increase spread % and enhance profitability… this should be a positive for UPST as well
Also with government stimulus off towards end of Q3, 2021; need for unsecured loans, small loans by individuals is expected to increase (compared to previous 4 quarters)
With inflation and increasing prices, consumer’s dependence on loans / credit increases
If there is a negative on UPST business due to inflation or increasing interest rate, I have not seen it articulated anywhere… maybe I am missing something
The biggest single negative for UPST vs interest rates incrementally going up are two fold:
Sell through of their loan portfolios (securitization) will require a larger promote and a higher yield on capital. That will pinch their product pass through to non bank customers (investment banks, private equity, etc.)
… this is because the hurdle rate for risk free rates will increase, requiring additional costs in the portfolio as part of financing expense.
UPST may see some margin erosion if they cannot pass these costs on to the individual who take the loan.
The per loan fee for originations may see some pricing pressure as a proportion of total interest expense for each loan product.
This may be a challenge for UPST products against competing products. We know from prior posts in UPST research that captive customers of banks and credit unions are far less likely to shop around for rates, which would minimize this challenge to margins for Banks and Credit Unions. I see this having a larger impact on the Upstart.com products sold directly to consumers where they are likely to cross shop.
This next quarterly report (Q4) is not likely to show either of these impacts (if they are significant) as this change will not likely occur until we see FOMC rates increasing significantly from here. Q3-Q4 next year will be more telling as the incremental interest rate changes will not be significant until those periods in time.
Of course, movement on news and sentiment happens long before the results.
The volume of loans (and loan fees) will continue to be my primary indicator for growth and effectiveness of the business model.