Anytime a stock drops more than 90% from its 52-week high, investors may consider it a bounce-back candidate. Prolific investor Michael Burry of The Big Short fame once wrote, "My strategy isn't very complex. I try to buy shares of unpopular companies when they look like road kill and sell them when they've been polished up a bit."
One stock that looks like roadkill right now is Carvana (CVNA 8.79%), which is down 91% over the past year. However, investors looking for a quick turnaround for the online retailer of used cars should tread lightly. Here are three red flags that show Carvana stock is a depreciating asset.
1. Revenue is flat
For growth stocks, revenue is arguably one of its most important metrics because it shows whether popularity or usage increases among consumers over time. So even if a company is unprofitable -- which Carvana is -- management can always cut costs or make its business model more efficient to find a path to profitability.
However, once a growth company's sales flatten or decrease, the thesis gets turned on its head as potential evaporates. Instead, the company must cut costs while simultaneously reworking its business model to grow its revenue again.
This happened to Carvana, as the company sold 102,570 units in Q3 2022, a decrease of 8% from Q3 2021. The resulting revenue was $3.386 billion, a decrease of 3% from $3.480 billion in Q3 2021.
2. Burning cash
For the first nine months of 2022, Carvana lost $1.4 billion, and $781 million of that loss could be directly attributed to its core business. As a result of burning through cash, the company has had to take on long-term debt.
Specifically, the company issued roughly $3.5 billion in long-term debt, bringing the total to about $7 billion. And zooming out, Carvana's long-term debt has increased nearly 600% in just two years, from $1 billion to $7 billion.
CVNA Total Long Term Debt (Quarterly) data by YCharts
Another tactic management tapped into to raise cash over the past year was issuing more Carvana common stock shares. While the move resulted in over $1.2 billion in cash for the company, it added nearly 25% to its outstanding common shares, from 86 million to 106 million. As a result, shareholders' ownership has been significantly diluted over the past year.
Worse yet, the company is showing no signs of reversing that trend anytime soon, as share buybacks appear unlikely, given its financial situation.
3. Broader economic challenges
Over the past few years, Carvana has benefited from low interest rates and the higher-than-average prices of used cars. However, the economy has shifted over the past year to higher interest rates, causing lower demand for vehicle price depreciation.
According to Carvana CEO Ernie Garcia, management is assuming that 2023 will be "a difficult [year] in our industry and in the economy as a whole."
With interest rate hikes having already occurred in 2023, Carvana customers looking to finance cars are looking at prices at the "most unaffordable point ever," according to Garcia. So, according to management, as the consumer's spending tightens, Carvana's sales will likely continue to falter.
Is Carvana a buy?
It's tempting to look at any stock down more than 90% and see the opportunity for it to bounce back. However, investors should look to the fundamentals to see if a stock has a legitimate shot at a long-term reversal. Right now, Carvana's risk appears to outweigh the potential reward.
