An opportunity has arisen following the price correction for Upstart Holdings (NASDAQ:UPST) stock after a disappointing third quarter earnings. The artificial intelligence (AI) driven lending platform had been plagued by over-valuation concerns weeks before earnings were released. Prices had already peaked in mid-October.
That said, it was somewhat surprising when earnings sent it off a cliff on Nov. 9. That’s because, Upstart Holdings did come in above guidance in several important regards. That’s a great place to start.
Strong Results, But Downturn
According to Barron’s, it was hard to comprehend why UPST stock’s Q3 earnings was a downturn: “When it comes to earnings, it was more of the same in the third quarter as the company posted strong revenue growth and better-than-expected guidance. Upstart (ticker: UPST) reported revenue of $228.5 million in the three months to Sept. 30, a 250% increase from 2020 and ahead of the FactSet analysts’ consensus for $215 million. Adjusted earnings per share of $0.60 beat estimates of $0.33.”
Because Upstart Holdings beat those expectations, there were some confusion as to why it should suffer, dropping 18% on the news. There are some glaring issues that likely contributed heavily to the steep drop. However, the most obvious is that of net income — and that is likely to be a continuing problem for a few reasons.
Decreasing Gains for UPST Stock
Simply put, Upstart Holdings suffered a decrease in net income between Q2 and Q3. Net income decreased from $37 million to $29 million in the period. That jumps off the page, and it’s something investors simply can’t ignore. Given that UPST stock was already arguably overvalued leading to the news, it’s no surprise it dropped so dramatically.
Couple that with “likely cost increases in order to maintain growth” in the forward guidance and you might wonder why I characterized UPST as an opportunity currently.
I simply meant that UPST shares represent a contrarian opportunity, or a chance to buy the dip. However, I don’t think you should take that opportunity. In fact, there’s good reason to believe prices could fall further soon.
Expectations Aren’t Appealing
Yes, Upstart Holdings anticipates reporting a revenue range between $255 million and $265 million in Q4. If that materializes, it will represent a 12%-16% increase in revenues sequentially. Normally, that equates to increasing prices.
However, net income is again expected to decrease. The company has given guidance that it expects from $16 to $20 million in net income in Q4. That’s less than the $29 million reported in Q3, which was itself a sequential decrease.
So, when the company noted “likely cost increases in order to maintain growth,” it really meant decreasing efficiency. The top line is growing again, but in order to maintain that momentum, the firm is spending more money.
That is fine if it results in improving margins — in this case, it doesn’t. The number that will be important to track between now and Q4 won’t be revenue. Rather, net income will be the most important correlate with prices.
UPST Stock: What to Do
The same Barron’s article mentioned above also noted that Upstart Holdings said “incremental upside appears lower now given normalizing credit and increasing competition for these loans.”
I already noted that Upstart Holdings suffered decreasing margins and net income in Q3. The company now reports that increasing competition for the loans it targets is increasing. That will only serve to add increasing downward pressure on margins. Net income could end up even lower than the company’s already low Q4 guidance.
That’s why I don’t see any reasonable argument for investing in UPST stock at present. In the loans business, margins are vitally important. Upstart Holdings has a problem there and shouldn’t rise until it reverses that trend. Its AI technology angle might lure some investors in, but that won’t matter when those aforementioned issues cut into the bottom line.
On the date of publication, Alex Sirois did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Alex Sirois is a freelance contributor to InvestorPlace whose personal stock investing style is focused on long-term, buy-and-hold, wealth-building stock picks. Having worked in several industries from e-commerce to translation to education and utilizing his MBA from George Washington University, he brings a diverse set of skills through which he filters his writing.