What happened
Shares of Carvana (CVNA -0.36%), an online car buying and financing platform also known for its giant car vending machines, were surging 15% higher Wednesday with no direct news about the company. Here's why a short squeeze could be happening.
So what
Carvana has been an intriguing company from the get-go, and its soaring stock has made it even more interesting. It's up 881% in just under three years as a publicly traded company. While that's made many investors happy, it's also brought out plenty of short interest.
When short-sellers borrow and then sell a company's stock at what they believe to be an overvalued price, they're required to buy those shares back later. If the short-sellers later believe they made a mistake as the stock they shorted continues to rise, they could buy the shares back in a panic to avoid further losses.
As short-sellers cover their position, the short-term boost in demand will propel Carvana's stock higher -- 54% of Carvana's float is sold short, and its short interest ratio is approaching 12. Here's a detailed breakdown of how those two ratios work, but suffice it to say there is plenty of short interest for a short squeeze to be happening Wednesday. Short-sellers might be concerned that Carvana's Feb. 26 fourth-quarter earnings results could send its shares even higher, a risk some aren't willing to take.
One of Carvana's car vending machines. Image source: Carvana.
Now what
Carvana is currently focused on expanding its business quickly, and it's been successful. In its most recent quarter, it reported retail units increased 83% compared with the prior year, and it recorded its 23rd consecutive quarter of triple-digit revenue growth.
But Carvana's rapid growth is expensive, and investors will eventually want to see the company take steps to turn a profit. Investors should take short squeezes, and similar drops, with a grain of salt. Carvana is a young company with immense potential, albeit in a competitive industry. And there will be a decent amount of uncertainty as its top line continues to expand rapidly and its losses continue to mount.
