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Is Carvana The Amazon Of Cars?

By Taylor Carmichael – Oct 6, 2019 at 9:00AM

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An internet retailer is in the midst of disrupting a massive industry, and it's happening right before our eyes.

An internet stock is upsetting brick-and-mortar retail. Customers are flocking to the website. The revenue growth is astounding. The stock is extremely volatile, and the shorts are piling on. 

I was an owner of Amazon's (AMZN -1.57%) stock back in 1999. And now, 20 years later, I own shares of Carvana (CVNA -5.89%). And yes, there is a strong feeling of déjà vu. This is particularly true when the bears make some attack. And I say to myself, "Wow, I've heard that one before."

For instance, a SeekingAlpha.com blogger called WY Capital has a "short idea" about Carvana and said, it "masquerades as a technology company even though it is an auto dealer." This was a constant refrain about Amazon in the old days. If you think "auto dealer" is insulting, wait until somebody calls you a "bookseller." The Amazon bears would go to great lengths to disparage Amazon, but the most common insult was "all it does is sell books." 

And then Amazon expanded its offerings. Amazon started selling music and selling videos. The bulls got so excited every time Amazon opened another store -- and the bears were apoplectic. Comparisons were made, over and over, to the bookseller, Barnes & Noble (BKS).

Carvana auto tower

Image Source: Carvana.

Yes, Carvana sells cars. The company is famous for its car towers, but that's just a brilliant marketing strategy. What Carvana is doing is using the internet to increase the options a car buyer has. Instead of going to a physical lot and looking at 200 cars, you can go to Carvana's website and shop from its 14,000 cars.

It's true that Carvana is highly unlikely to expand into, say, yard equipment. The company will probably stick to automobiles. But Carvana does not need to expand into Amazon's turf to survive and thrive. The market for books is fairly tiny; in 2017, it was $26 billion in the U.S. The automobile market is beyond big: $1.2 trillion in the U.S. alone. Buying and selling cars represents 21% of the entire U.S. retail landscape.

So, yes Carvana is a retailer (just like Amazon), and it is using technology and the internet to destabilize existing markets (just like Amazon). But one of the things I love about Carvana as a retailer is that it is not competing with Amazon. Amazon has a huge brand, and it is a dangerous competitor. But selling cars is quantitatively different from selling small-ticket items. That's presumably why Amazon has yet to get into the car-selling business.

What this means is that Carvana is competing with brick-and-mortar retailers. And we all know how this story ends. The internet is faster, cheaper, and better than brick-and-mortar retail. Just ask the CEO of CarMax, he'll tell you: Online car buying is the future.  

"And it doesn't make money"

The other common refrain from 1999 was that Amazon was unprofitable. It was obvious to everyone, even the bears, that Amazon was shooting for the moon. The company had massive revenue growth, and it wasn't making any profit while it was building out its business. The idea was that as the company got big enough, Amazon would scale to profitability. And that is exactly what happened. 

So it's quite strange to hear the same arguments being made against Carvana 20 years later: Carvana is a retailer, and retailers have awful margins, and they are unprofitable. Carvana's astounding top-line growth is simply cast aside as irrelevant.

That's a mistake. Growth is just as important a concept as profitability. To focus on one and ignore the other is a dangerous practice.  

Instead of ignoring revenue growth, let us borrow a concept from the software industry. Venture capitalists have a very useful statistic to measure the viability of early stage software-as-a-service (SaaS) companies. It's called the Rule of 40. You add a company's profit margin to its annual revenue growth, and if that number is higher than 40, you might have a strong investment. 

I am of the opinion that this rule can and should be applied to many investments, not just SaaS start-ups. The reason I like it is that it requires investors to pay attention to both the top line and the bottom line. For instance, let's compare the numbers of two internet retailers: Carvana and Sea Limited (SE). I see Carvana as the Amazon of automobiles, and Sea Limited is the Amazon of southeast Asia. So how do these internet retailers match up under the rule of 40?

Retailer Revenue Growth Profit Margin Rule of 40 Score
Carvana 107% (3%) 104
Sea Limited 137% (115%) 22

These numbers speak for themselves. Sea Limited might be a good investment going forward. The top-line growth is outstanding. But the company is simultaneously bleeding dollars. It's bad enough that it's keeping me on the sidelines.

Carvana, on the other hand, looks like a fantastic investment. It's an internet retailer with sky-high revenue growth, and it's almost breaking even on the bottom line. What's not to like?

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Taylor Carmichael owns shares of Amazon and Carvana Co. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Carvana Stock Quote
Carvana
CVNA
$20.30 (-5.89%) $-1.27
Amazon.com, Inc. Stock Quote
Amazon.com, Inc.
AMZN
$113.00 (-1.57%) $-1.80
Barnes & Noble, Inc. Stock Quote
Barnes & Noble, Inc.
BKS
Spectra Energy Corp Stock Quote
Spectra Energy Corp
SE

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