Artificial intelligence (AI) stocks are all the rage on Wall Street, and the reasons are easy to see.

Stocks like NVIDIA have risen sharply since ChatGPT launched nearly two years ago, creating trillions of dollars in market value for investors. However, Wall Street isn’t excited about every AI stock on the market.

Take upstart (NASDAQ:UPST)for example. The AI-based consumer credit provider has been struggling recently, and Wall Street is downright pessimistic about it. Of the 18 analysts who cover the stock (tracked by The Wall Street Journal), only one recommends the stock as a buy and eight recommend as a sell. The average price target for the stock is $23.47, which represents about 40% downside risk from current value.

However, since the release of its quarterly report on August 6, the stock has risen sharply and looks like further gains are possible. Here are two reasons why.

Image source: Getty Images.

1. Interest rates will fall

Upstart’s business, like most lending companies, is highly interest rate sensitive. In 2021, shortly after the company’s IPO, business boomed as interest rates were at rock bottom and demand for consumer loans was high during the pandemic. Not only did the company grow quickly with triple-digit revenue increases, but its operating margins were strong, in the double digits.

But as interest rates rose and fears of recession gripped the market and the economy, business ground to a halt and stock prices plummeted.

Now the company has a chance to recoup some of those losses. The Federal Reserve will most likely start cutting interest rates at its next meeting in September. That would ease the pressure on companies like Upstart and boost demand for loans again.

It will take some time for falling interest rates to stimulate demand, but the Fed expects rates to fall below 3% over the long term, from 5.25% currently to 5.50%, which should provide a significant boost to borrowers.

The share price is likely to rise when interest rates begin to fall.

2. Technology is still an advantage

Upstart shares rose sharply following its latest earnings report, even as revenue continues to decline and losses rise.

However, the interest rate conversion rate improved to 15% from 9% in the same quarter last year, showing that more applicants are receiving loans. In addition, revenue growth is expected to pick up in the second half of the year.

Moreover, Upstart’s technology still shows a lot of promise. The company claims its AI-based credit model is more accurate than traditional models like the FICO score. For example, in the second quarter, loan approval rates were twice as high as traditional models and it achieved an APR that was 38% lower than competing models.

The company has also grown significantly since the boom in 2021. Back then, it did not offer a home equity loan product, but today it offers a home equity line of credit in 30 states and the District of Columbia.

Finally, the company’s own Upstart Macro Index shows an improvement in conditions, which will lead to lower default rates and an increase in loan approvals.

Why Upstart is a buy

Upstart’s difficulties are not due to any fundamental problems with its product. Its business is simply highly cyclical, and poor macroeconomic conditions in the form of higher interest rates have dampened demand.

However, the Fed’s reversal in monetary policy is likely to unleash pent-up demand for consumer credit, similar to what is likely to happen for mortgages in the housing market.

Under better market conditions, Upstart has the potential to deliver the kind of gains that investors were already expecting in 2021, when the company ended the year with generally accepted accounting principles (GAAP) net income of $135 million and adjusted net income of $224 million. A return to those levels would give the company a price-to-earnings ratio of 16 (based on adjusted earnings) at the current share price.

As soon as the company records sales growth and profits again, a significant increase in the share price is possible.

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Jeremy Bowman has a position in Upstart. The Motley Fool has a position in and recommends Nvidia and Upstart. The Motley Fool has a disclosure policy.