Upstart (NASDAQ:UPST) Illustrates the Risk Inherent in High P/E Stocks

Upstart Holdings, Inc's (NASDAQ:UPST) share price came under pressure yesterday, giving up 18%, after the company released results that were well ahead of consensus estimates. The company’s forward guidance (revenue to rise 209% year-on-year) would normally be extremely bullish. But, clearly the market expected even more. This illustrates the risk that stocks priced for perfection carry.

Third Quarter Highlights:

• Revenue up 250% YoY to $228 million vs $215 million expected.
• EPS up 253% YoY to $0.60 vs $0.27 expected.
• Bank partner originated loans up 244% YoY to $3.13 billion
• Conversion on rate requests up to  23% vs 15% a year ago. 
• Fourth quarter revenue guidance between $255 and $265 million, up ~209% YoY
• Fourth quarter net income guidance between $16 and $20 million, up ~85% YoY 

By most accounts this was a very good result, but the market appears to have been hoping for more. Back in September when the stock was trading on a price-to-earnings (or "P/E") ratio of 482x we pointed out that forecasts would need to continue to rise to justify such a high P/E.

Ahead of these financial results the stock was trading on a P/E of 468x, and this has now dropped to 401x. This is still 22 times the P/E ratio of the average US stock which trades at 18x EPS.

Check out our latest analysis for Upstart Holdings

What Are Growth Metrics Telling Us About The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Upstart Holdings' is when the company's growth is on track to outshine the market decidedly.

Looking back, Upstart has delivered EPS growth of 253% over the last year, around 6 times the market’s growth of 41%. But, looking forward, analysts are expecting growth rates to slow considerably after the end of this year.If these analysts are correct, the stock is trading on a very high forward P/E as well.

What this means for Upstart’s shareholders 

Some of the best stocks to own over the last two decades have traded on very high P/E ratios for years. Unfortunately a lot of the worst stocks to own have traded on excessively high P/E ratios too. Ultimately it depends how long a company can maintain the very high growth rate before growth begins to slow.

Upstart does potentially have a very large TAM (total addressable market) so it’s entirely possible that it grows into its lofty valuation. But investing in high PE stocks does come with two distinct risks. Firstly, there is the risk that the company never generates enough earnings to justify the earnings multiple you pay for it. The second risk is the price volatility that is inevitable when a company has to continually impress the market.

Investing always involves risk, and it’s crucial to be aware of all the risks associated with a company. We've spotted 2 other risks for Upstart Holdings you should know about.

You might be able to find a better investment than Upstart Holdings. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a P/E below 20x (but have proven they can grow earnings).

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Simply Wall St analyst Richard Bowman and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.