2 battered stocks with tons of upside

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DocuSign (DOCU -4.10% ) and Reached ( UPST -6.86% ) both posted strong results in their final quarters, but their stock prices did not reflect that. Abnormal and sky-high investor expectations have left these stocks selling. Here’s why the two still have a significant advantage.

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The Huge DocuSign Opportunity

DocuSign is down 60% from its highs following investor overreaction to its Q3 2021 billing decline. Despite this, the company is still healthy and growing. Its core product enables its 1.1 million corporate customers worldwide to sign and collect signatures electronically, accelerating and simplifying a process previously done with pen and paper. With just $1.5 billion of the $50 billion digital signatures and agreements market within reach, DocuSign has a huge and growing market opportunity.

As this market grows, so does the business. From the third quarter of 2020 to the third quarter of 2021, its subscription revenue increased by 50%. Overall revenue grew 35% in 2019 and 39% in 2020, and management expects 49% growth for 2021.

International revenue currently represents only 23% of its total revenue, but it is growing very rapidly: 68% year-over-year in the last quarter. To continue to benefit from this growth, DocuSign must keep an eye on regulatory risk overseas; some of the countries where it is currently growing fastest are questioning whether e-signatures are too prone to fraud.

DocuSign is trying to lock in its place in the market with its analytics tools, which its main competitor, Adobe ( ADBE -3.31% ), lack. Agreements between two parties often require extensive and sometimes costly reviews. DocuSign Analyzer uses AI to determine risk and summarize key deal points. This exclusive feature helps DocuSign attract and retain customers: existing customers spent 21% more year-over-year in Q3 2021, compared to 17% in Q3 2020, suggesting DocuSign remains in good health despite increasing competition.

Even so, the company is not immune to the effects of the pandemic. As businesses rushed to go digital, they drove demand for DocuSign’s services; the company grew faster than expected last year but slower than expected this year, leading to slower growth and lower billings in the third quarter that dismayed investors. But while the stock has tumbled, the company is still firing on all cylinders. As DocuSign grows, the growth will naturally slow down, but it clearly won’t stop.

Upstarts even bigger opportunity

Upstart took off like a rocket when it went public in December 2020, and it has remained a market darling throughout 2021. In the second quarter of 2021, it exceeded analysts’ earnings per share estimates by 148% and raised its forecast for the full year. Investors were thrilled, driving the stock price up 187% to a record high. But the company couldn’t sustain that outperformance in the second quarter, and the overall market deteriorated on growth stocks, slashing Upstart shares by more than 60%. This gives the stock a more attractive valuation for its strong competitive advantages and huge market opportunities.

Upstart is an artificial intelligence based lending platform. Its algorithm takes thousands of data points to determine whether or not someone can qualify for a loan. Currently, most banks rely on FICO scores to make these judgments. Upstart claims that 80% of Americans have never defaulted on a loan, but FICO scores indicate that only 48% of them are qualified to receive a loan. Upstart is trying to target the 32% of eligible borrowers that FICO misses. Upstart bases its judgments on a much larger data set than that used by FICO, giving banks a better picture of the true risk of each potential loan – and enabling more people to qualify for loans.

Banks pay an Upstart referral fee in exchange for this initial security check. Typically, Upstart qualifies a person for a loan and then refers them to one of their banking partners for that loan. This bank pays Upstart’s small referral fee on the principal of the loan. Upstart aims to help banks issue more loans with similar or better default rates.

Upstart has a huge market opportunity. Currently, it primarily targets personal loans, referring $8.9 billion in loans over the past 12 months, just under 10% of an $81 billion market. But the company plans to expand into auto and mortgage lending, which would bring its total addressable market to $5.2 trillion. A large addressable market does not mean a business will succeed, but when the business is growing in a growing market, it can be a great signal.

Big banks could create their own algorithm and directly compete with Upstart, but they would struggle to match its current lead. The longer AI algorithms are used and the more data they collect, the smarter they become. Upstart has years of data to refine its algorithm, giving potential rivals a significant hurdle to clear if they want to catch up.

Two actions, two purchases

Upstart and DocuSign may continue to suffer from general market skepticism toward growth stocks. But buying now could pay off when investors look back years later. The current slump in both stocks presents investors with the opportunity to buy these stocks — and their strong competitive advantages in large growth markets — on the sell side.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.

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