How to Judge a Fintech Stock Before You Buy It

If investors want to pick individual companies for their portfolios, more work is required than if they choose to go the passive route. Researching businesses takes time and effort. It's not always an easy process. But curiosity can take you far, especially if you're searching in an exciting industry.

When analyzing a fintech stock, for instance, here are two of the most important factors that investors should look at before coming to an informed conclusion. Upstart Holdings (NASDAQ: UPST) can provide a valuable case study on this topic.

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Do you understand the business model?

Some of the greatest investors ever, like Peter Lynch and Warren Buffett, focused relentlessly on owning companies that they knew very well. This seems like an obvious requirement, but it's easy to fool yourself into thinking that you have a solid understanding. In the fintech world, many companies look similar. It's critical to figure out their specific business models and how they make money.

There's no denying that Upstart is one of the most exciting companies in this corner of the market. That's probably because it has been working on artificial intelligence (AI) capabilities ever since it was founded more than a decade ago. It's not just hopping on the bandwagon of the latest technological trend.

This business has developed (and continues to improve) an AI-powered credit assessment tool that looks at over 3,000 unique variables about potential borrowers. The objective is to better analyze the default risk, while providing more access to credit to borrowers who might not be approved by traditional lenders. This is a challenger to the entrenched FICO scoring model.

Upstart generates revenue by providing its AI tool to lending partners, including more than 100 banks and credit unions, and collecting fees any time a loan gets approved. The company currently offers personal loans, auto loans, and home equity lines of credit. Now that it's received a bank charter, it's planning to launch Upstart Bank in early 2027, allowing it to accept consumer deposits.

Upstart aims to not keep these loans on its balance sheet, instead offloading them to capital providers. As of June 30, it did carry $1.1 billion in loans on its books. but 94.1% of loans outstanding were held by third parties.

Growth has been volatile. As expected, Upstart is heavily exposed to the changing macroeconomic climate. When interest rates are declining low, demand from borrowers picks up. This drives rapid transaction volume and revenue growth, as was experienced during 2021.

However, when credit conditions tighten, the business's expansion hits the brakes. This is what happened in 2023.

Upstart management is forecasting revenue of $1.4 billion in 2026. This would be 40% higher than last year's total. Maybe the biggest uncertainty is how this company performs over an entire credit cycle. It hasn't yet been tested in a recession (not including the short pandemic-driven 2020 downturn). This presents a risk.

Is the company reporting positive earnings?

Profitability is another key part of judging fintech stocks. These kinds of businesses are generally characterized by fast growth. Their leadership teams invest aggressively in research and development and marketing to capture what they believe to be significant market opportunities. Consequently, reporting positive GAAP earnings is an afterthought in the early stages.

Because Upstart's loan activity and revenue trends have been choppy historically, so too has its bottom-line performance. The business generated $135 million in net income in 2021. It followed with three straight years of operating in the red, with cumulative net losses from 2022 through 2024 of $478 million.

Last year, Upstart turned things around. It posted $54 million in net income.

The encouraging part is that this company has proven that it can report profits. The main question centers on its ability to do so in a sustainable manner.

Once Upstart proves it can grow revenue and net income consistently over a long period of time, the business becomes more attractive as an investment candidate.

Neil Patel has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Upstart. The Motley Fool has a disclosure policy.