This year has started out great for growth stock investors. Many companies that were down 50% or more in 2022 have soared since the calendars turned over on Jan. 1. Online used card marketplace Carvana (CVNA 6.05%) is an extreme example of this trend, with shares soaring 16% in 2023 after falling a staggering 98% in 2022. Could this indicate that the worst is over for Carvana shareholders? I think that is unlikely.
Investors are bidding up shares of Carvana to start 2023. Here's why this is just noise and why you should avoid buying the stock today.
The rise and fall of a once-loved growth stock
Carvana was one of the hottest stocks of the 2019-2021 bull market. At one point, shares were up 3,000% since the company went public in 2017, hitting a market cap of over $60 billion. Today, shares are down 50% from the initial public offering (IPO), and the total market capitalization of the company sits at $1.2 billion, a shocking turn of events for a fan favorite in the growth investing community.
What happened? First let's look at why investors saw so much promise in Carvana's business model. The company operates an online used car marketplace, connecting buyers and sellers of vehicles and cutting out the need to go to dealerships. With radical ideas like gigantic car vending machines, a seven-day return policy, and free delivery services, Carvana started to gain rapid adoption among younger consumers. Once the pandemic hit, this adoption went into high gear, accelerating the company's revenue growth. From its IPO through the end of 2021, Carvana's revenue was up 3,400%, making it one of the fastest-growing businesses in the world.
CVNA Revenue (TTM) data by YCharts
In 2022, Carvana started facing multiple headwinds. First, with the Federal Reserve raising interest rates, it became much harder for consumers to finance car purchases, decreasing buyer demand on Carvana's marketplace. Second, used car prices started to quickly fall from all-time highs. Since Carvana buys vehicles from individuals and then turns around and sells them to buyers, rapidly falling car prices can have a big impact on its margins. Both of these factors have started to show up on Carvana's financial statements, with units sold decreasing 8% year over year last quarter and total gross profit falling 31%. If used car prices fall in 2023, this gross profit crunch will only continue.
Focus on liquidity issues
Carvana's deteriorating gross margin due to declining used car prices is something to track, but this isn't the largest concern for Carvana's business today. What investors really need to worry about with Carvana is whether it will run out of money. Last quarter, Carvana reported just $316 million in cash on its balance sheet while burning over $1 billion in free cash flow through the first nine months of this year. The company will also struggle to raise money through stock issuance because of how depressed the share price is, and will likely not be able to add any new debt because it already has $6.6 billion of long-term debt on the balance sheet. Carvana needs to trim its costs and get profitable, and fast, or it risks going out of business sometime in 2023.
So why has the stock been so volatile this year? I think there are a few factors at play. First, Carvana has extremely high trading volume, with a good percentage of its shares outstanding trading hands each day. Second, with the stock down over 95% in the past year, many larger investment funds that owned it at a much higher market cap have likely decided to exit their positions. Third, the stock has one of the highest short interests on the market of around 50%, meaning that 50% of its shares have been loaned to short sellers and will not become part of the publicly traded float unless these short sellers buy back their positions. Add up all these factors and it looks like Carvana has a ton of investors trying to trade on an increasingly illiquid stock, which is a recipe for high volatility. These price movements have nothing to do with Carvana's underlying business.
Even though the stock has rocketed higher to start 2023, there are too many risks with Carvana to warrant consideration for any investor's portfolio today.
