Inflation Mania: 2 Growth Stocks Riding the Boom in Car Prices

Not only is inflation running hot, it's also the hottest topic of discussion among investors.

Rising prices on goods and services are a natural part of our economic system, but if they rise too quickly, it can disrupt consumer spending and slow the economy down. The Federal Reserve typically likes the inflation rate to hover around 2% per year, but in the 12 months ended in September, it rose by 5.4%. Some economists describe the rise as transitory, meaning it's being caused by short-term issues like supply chain disruptions from the pandemic. But there are concerns inflation might stay higher for longer.

Used car prices, for instance, have exploded 24.4% higher over the last 12 months, with new cars up a robust 8.7% over the same period. The culprit is a shortage of crucial manufacturing components like semiconductors, which is crippling the supply of new vehicles.

Here's how Ally Financial (ALLY -0.07%) and Carvana (CVNA 5.85%) have converted this car-price boom to all-time high stock prices. More importantly, let's explore whether it can continue.

Image source: Getty Images.

Ally Financial: A leader in vehicle finance

Ally Financial is America's No. 1 all-digital bank, and it's a car lending specialist, with 20,400 dealer relationships across the country. It currently holds over $101.2 billion in automotive loans (which is the largest retail book in the industry) and derives over 62% of its revenue from this segment.

When car prices rise across the board, the amount a consumer must borrow to purchase a car therefore also rises. Based on the inflation data mentioned above, a used car loan would be an average of 24.4% larger today than the same loan 12 months ago, and used car loans were 64% of Ally's consumer vehicle lending in the recent third quarter; that's up from 55% in the same quarter last year.

And Ally continues to see strong gains in off-lease vehicles that it remarkets, thanks specifically to the general rise in used car prices. A combination of these factors is set to drive significant earnings growth compared to last year. 

Data source: Ally Financial, Yahoo! Finance.

Ally's current total loan book of $101.2 billion is actually down by $3.6 billion from 12 months ago, simply because consumers can't get their hands on new cars. It's reflected by the company's all-time high 3.3 million third-quarter loan applications. The demand is clearly there, but the supply is not.

However, Ally stands to benefit significantly if inflation persists and interest rates begin to rise. It would mean that all the new loans it has delivered at record car prices would also generate higher income over time, too. 

Image source: Getty Images.

Carvana: Transforming car sales

While Ally Financial finances cars, Carvana sells them. Its focus is solely on used cars, and it has rocketed up the ranks to become the second-largest dealer in America -- except it doesn't have any traditional dealerships. 

Most of Carvana's transactions are done online, and that includes making offers on cars people would like to sell (or trade in), which are picked up and delivered as necessary by one of the company's employees. Carvana does have 28 physical retail locations, but they take the form of giant vending machines where customers can schedule test drives or deliver trade-in vehicles.

Its focus on used cars means it has experienced spectacular growth on the back of the 24.4% rise in prices over the last 12 months.

Data source: Carvana. TTM = trailing 12 months.

Gross profit per unit is the most significant measure of this success. The company makes net losses overall, but increasing gross profit is a step in the right direction toward positive earnings for investors. This will only improve further if car prices continue to rise, and the data suggests they might, at least in the near term.

The Manheim Used Vehicle Value Index analyzes the sale of 5 million vehicles annually to track movements in car prices at auction houses. The October reading just came in, and it reached an all-time high of 221.8, a 37% increase compared to October last year.

History dictates that used cars shouldn't be relied upon to rise indefinitely; in fact, they typically fall in value over time. But Carvana's inventory continues to grow in value in the short term, and it should remain strong for as long as new car shortages persist, which some manufacturers think will be well into 2022.