Analyzing Upstart’s Financial Performance and Market Perception for Investment Decision-Making”

QUESTION

Would you Invest in Upstart? Upstart is a tech company that uses a proprietary AI algorithm to determine a person’s true risk of defaulting on a loan. Traditionally, credit unions such as TransUnion, Experian and Equifax are used to give a credit rating, such as 600 or 700 and so forth. These numbers erroneously exclude a tremendous number of people from the loan market which is financial discrimination. Some people have a low credit score because they never had a lease, mortgage, car loan, and don’t have a high income, but they are unlikely to default and can never get out of this financial rut. This hurts the economy, the individual, and banks’ profitability in lost opportunity for earning interest on low risk loans. Upstart claims that their AI algorithm will allow billions of dollars to be loaned without any increase in risk. The company went public in December 2020 and they are already realizing a profit. However, they are a very young company and it’s not clear if large banks will welcome Upstart’s algorithm, or if this is a just another tech fad that analysts are in love with for the moment. Given this background of the company, let’s look at the most recent quarterly report https://ir.upstart.com/node/7331/html#i944194df87164bc1897bce1f47b438d5_22 (the 2021 annual report doesn’t come out for another week). Specifically, please use the numbers that refer to 9 months ending Sept 30, 2021 (some of the statements also report 3 months ending Sept 30,2021) 1. Use the balance sheet and statement of operations (income statement) to calculate the following profitability metrics: a. ROE b. ROA c. ROC 2. Now let’s calculate some liquidity ratios a. Current ratio b. Cash ratio – using only “cash” (the company doesn’t seem to report marketable securities so let’s exclude this) 3. Finally, using a share price of $105, and outstanding shares of 81.96 million, calculate the following a. Market value b. Market value added c. Market to book value Do you find the answers from question 3 are disproportionate to the answers from question 1? What does this tell you about how the market views Upstart? Considering these answers, would you invest in Upstart, and would you consider this low or high risk, and would you expect low or high returns with a 3-5 year horizon?

ANSWER

Analyzing Upstart’s Financial Performance and Market Perception for Investment Decision-Making”

Investing in a company like Upstart, which aims to disrupt the traditional lending industry with AI-driven credit assessment, can be a promising but high-risk venture. Here are some key factors to consider:

 Profitability Metrics: a. Return on Equity (ROE): ROE measures a company’s ability to generate profit from shareholders’ equity. A higher ROE generally indicates better financial performance. A high ROE may signify that Upstart is efficiently using its equity to generate returns.

Return on Assets (ROA): ROA assesses how effectively a company is utilizing its assets to generate profits. A higher ROA suggests efficient asset utilization.

c. Return on Capital (ROC): ROC evaluates the returns generated from both equity and debt. It provides a comprehensive view of the company’s ability to generate profits from all invested capital.

Liquidity Ratios: a. Current Ratio: This ratio measures a company’s short-term liquidity. A current ratio greater than 1 suggests that the company can cover its short-term obligations with its current assets. It indicates financial stability.

Cash Ratio: The cash ratio focuses specifically on a company’s ability to meet its short-term obligations with cash on hand. It provides a more conservative measure of liquidity compared to the current ratio.

Market Metrics: a. Market Value: Market value is the total value of a company’s outstanding shares multiplied by its share price.

Market Value Added (MVA): MVA measures the difference between the market value of a company and the total capital contributed by investors. A positive MVA suggests that the company has created value for shareholders.

c. Market-to-Book Value: This ratio compares the market value of a company to its book value (assets minus liabilities). A high market-to-book ratio can indicate that investors have high expectations for future growth.

Market Perception vs. Financial Performance: Disproportionate answers between profitability metrics (ROE, ROA, ROC) and market metrics (market value, MVA, market-to-book value) may suggest that the market has high expectations for Upstart’s future growth and potential disruption of the lending industry. Investors may be willing to pay a premium for its shares based on these expectations, even if the company is not yet highly profitable in the short term.

Investment Decision: Investing in a company like Upstart is speculative and carries inherent risks. The success of Upstart’s AI algorithm in revolutionizing lending practices remains uncertain. Furthermore, competition in the fintech space is fierce, and regulatory challenges can pose significant hurdles.

Before investing, consider your risk tolerance, investment horizon, and diversification strategy. Investing in a high-growth, high-risk company like Upstart can potentially yield substantial returns over a 3-5 year horizon if the company achieves its goals. However, it’s essential to be prepared for volatility and the possibility of losses.

A prudent approach would be to conduct thorough research, diversify your investment portfolio, and consult with a financial advisor who can provide personalized guidance based on your financial goals and risk tolerance. Assessing the company’s long-term viability and the sustainability of its competitive advantage should be a critical part of your decision-making process.