Coined in 2020, meme stock refers to beaten-down, unprofitable companies with share prices massively inflated by retail investors looking to trigger short squeezes. This type of trading behavior seems to be reemerging in companies like Carvana (CVNA 2.88%) and Bed Bath & Beyond (BBBY) and could be riskier than it looks on the surface. Let's discuss why investors should think twice before jumping on these hype trains.
Carvana: 65% of the float sold short
Carvana stock hit the ground running in 2023, with its share price up by over 200% year to date, despite little to no fundamental improvements in its operations. Unfortunately for investors, a combination of tightening macroeconomic conditions and spiraling losses will make it hard for this used car dealership to hold on to its gains over the long term.
Going public through an initial public offering (IPO) in 2017, Carvana soon became a Wall Street darling because of its unique business model, which disrupts the used car market with an online-only strategy.
The business peaked at the height of the COVID-19 pandemic when used car prices soared amid supply chain shortages in the new car market and low-interest rates. However, now the used car bubble has burst as the Federal Reserve raises rates and the new car supply returns to normal levels.
While Carvana's third-quarter revenue fell by just 3% year over year to $3.4 billion, its net losses spiraled from $68 million to $508 million, highlighting the disastrous impact macro headwinds are having on margins.
The balance sheet is no better. At the end of September, the company had just $316 million worth of cash and equivalents left, compared to a whopping $6.6 billion in long-term debt.
If Carvana can survive these current headwinds, it could return to growth because of cyclical trends toward online shopping. But it is unclear whether that is possible without some type of restructuring or equity dilution, which could dramatically reduce current investors' claims on the company's future earnings in the event of a recovery.
Bed Bath & Beyond: 47% of the float sold short
With heavy volatility and almost half of its float sold short, Bed Bath & Beyond is the quintessential meme stock. The once-mighty home goods retailer is now cheaper than it was three decades ago. While the low price is eye-catching, investors shouldn't lose sight of the company's deteriorating operations and narrowing pathway to recovery.
Bed Bath & Beyond's third-quarter sales declined by a massive 33% year over year to $1.3 billion as it faced slowing customer traffic and closed unprofitable locations.
Consumer tastes seem to be evolving away from specialty big box retailers, and many have already failed. Toys-R-Us, Circuit City, and Sports Authority all went bankrupt in the 2000s and 2010s. Attempting to stay afloat, Bed Bath & Beyond is aggressively cutting costs through layoffs and supply chain efficiencies. But this wasn't enough to stop operating losses from jumping over fivefold to $451 million in the period.
Image source: Getty Images.
With just $153.5 million in cash compared to $1.94 billion in long-term debt, the company will struggle to sustain its operations without external capital.
In February, Bed Bath & Beyond raised $255 million in a dilutive equity offering and may receive an additional $800 million over the next three months if certain conditions are met. For the time being, this move might kick bankruptcy down the road, but it also reduces current investors' claims on the company's future earnings.
Investing shouldn't be a get-rich-quick scheme
Long-term investing is the key to sustainable returns in the stock market. And while it can be tempting to bet on low-quality meme stocks because of their explosive volatility, these companies can fall just as quickly as they rise. Investors should avoid Carvana and Bed Bath & Beyond because of their extreme losses and overleveraged balance sheets.
