FinTech stocks are currently some of the best performing investments in the market. Newcomer Upstart‘s (NASDAQ: UPST) share price is up 1,000% since this time last year. And at $336 today, it’s up 60% in the past month alone.
I think it’s artificial intelligence (AI) lending platform is the source of this rise. It claims to increase access to credit while reducing risks for financial lending institutions. This seems paradoxical, as increased lending has traditionally come with increased risk.
But it’s approved $13.6bn of loans already, 71% of them fully automated, without the need for human approval. Of course, it could be just another overhyped Fintech stock. Or it just might change money lending forever.
The traditional FICO model
In the US, FICO is an analytics company that generates credit scores for individuals and businesses. It has access to credit reports from the three major credit reference agencies — Experian, Equifax and TransUnion, which it uses to decide a FICO score. Some 95% of the largest US financial institutions use FICO scores, so it’s the most widely used score for consumer lending decisions.
Historical income, payment history, credit utilisation and account age are some of the traditional criteria used to determine a FICO score. But for decades, the system has been accused of unfairness at the individual level.
And as an innovative FinTech stock, Upstart believes that the FICO model is too limited to accurately quantify risk. It believes that banks are losing money by lending to high-risk customers on the basis of an unreliable system. But also, they’re missing out on lending to many low-risk customers as well.
Upstart completed a study in 2019 showing that 80% of Americans had never defaulted on a credit product, while only 48% had high enough FICO scores to access ‘prime credit’. This allows Americans much better access to consumer credit products. Astoundingly, banks may be missing out on generating higher profits from lending to almost a third of the US population.
Upstart is applying its AI model to the multi-trillion dollar credit industry. The AI doesn’t just use the traditional credit scoring variables. It also takes into account “non-conventional variables” such as employment history, educational background, banking transactions and cost of living. And due to its AI nature, the technology stock’s algorithm is constantly being updated with information on loan repayments and defaults.
Upstart claims that its AI “approves 26% more borrowers than the traditional model”. And in an internal 2017 study, its model yielded 75% fewer defaults at the same approval rate as traditional FICO-approved credit lending. I think that if the company demonstrates this level of success consistently in the real world, the sky could be the limit.
Risks for the FinTech stock
A key risk is that its AI could learn to discriminate against legally protected groups. While CEO Dave Girouard is confident about its fairness, the possibility is likely to remain a sticking point. And as AI becomes more widespread, regulation is becoming much tighter. In fact, 17 states have introduced new AI laws so far this year.
And some perspective is important. Upstart’s revenue in 2020 was $233.4m . That’s less than a fifth of competitor FICO’s $1.3bn. But I still think the FinTech stock is a good addition for my portfolio. There’s a very real chance it could be the next big thing.
Right now, this ‘screaming BUY’ stock is trading at a steep discount from its IPO price, but it looks like the sky is the limit in the years ahead.
Because this North American company is the clear leader in its field which is estimated to be worth US$261 BILLION by 2025.
The Motley Fool UK analyst team has just published a comprehensive report that shows you exactly why we believe it has so much upside potential.
But I warn you, you’ll need to act quickly, given how fast this ‘Monster IPO’ is already moving.
Charles Archer has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Upstart Holdings, Inc. The Motley Fool UK has recommended Experian. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.