While the S&P 500 is up 9% so far in 2023, it's still down about 13% from its all-time high. The Federal Reserve's aggressive interest rate hikes last year posed a headwind for valuations, but with inflation showing some signs of cooling down, maybe a bull market is on the horizon in the not-too-distant future. No doubt, investors would be happy to see this to happen.
In this type of scenario, a speculative stock like Carvana (CVNA 2.49%) might do well. In my opinion, this is still an extremely high-risk investment to make right now, particularly because there is a ton of uncertainty around its financial situation and long-term viability. Nonetheless, if a bull market is indeed coming, here are three reasons to buy Carvana shares.
Disruptive business model
The first and perhaps most obvious reason to take a closer look at Carvana is because of its disruptive and innovative business model. The company has built out a nationwide infrastructure, as well as digital tools, to allow customers to confidently buy and sell used cars online. This provides a massive selection of inventory, better pricing, and far more convenience. Selling online usually translates into a better user experience. The same thing could be said about used vehicles.
Compare this to a traditional brick-and-mortar used-car retailer. With the old method, inventory is limited, pricing isn't always transparent, the process can take all day, and customers might have to haggle with a salesperson. What's more, from Carvana's perspective, using an e-commerce model should result in better economics than having physical locations everywhere. Of course, this only works once a greater level of scale is achieved.
Based on Carvana's 2022 volume of 412,000 retail units sold, the business only commands about 1% of the typical 40 million or so used cars sold in the U.S. annually. That leaves an insanely large expansionary runway to continue stealing market share.
Fixing the financial situation
In 2022, Carvana's stock plunged a whopping 98%, largely attributable to its unfavorable financial situation that came to light as macro headwinds popped up. As of March 31, the company had $6.8 billion of long-term debt on the books, compared to just $488 million of cash and cash equivalents. The debt burden was made worse by the $2.2 billion acquisition of auction house ADESA last year.
This has pushed management to find ways of fixing its finances, especially in an economy where demand for used cars remains pressured. Key to this strategy is cutting costs. In the most recent quarter, Carvana sold 79,000 retail units, down 25% year over year. Revenue was also 25% lower. But selling, general, and administrative expenses declined by 35% versus a year ago. Moreover, Carvana's $1.51 loss per share was almost half the loss from Q1 2022. At least, this shows movement in the right direction.
Massive upside
As of May 19, shares of Carvana are down 97% from their peak set in August 2021. That's a monumental fall, and it highlights the struggles the company has been facing as well as investors' increasing pessimism about Carvana's prospects. The stock currently trades at a ridiculously cheap price-to-sales (P/S) multiple of 0.09. In its entire history as a publicly traded business, the average P/S ratio for Carvana shares is 1.3.
To be clear, a low valuation, no matter how extreme, doesn't make the stock a buy. But in Carvana's case, the situation means that there is incredible potential upside for investors should things continue to improve for the underlying business. For this to happen, though, Carvana needs a more favorable economic backdrop, which can help spur demand for used cars and get the company back to posting the remarkable gains it had before 2022.
One thing that is certain is that investor sentiment can change at the drop of a hat. Carvana's stock is up 127% so far this year. And after the business announced its first-quarter financial results, investors were so impressed with the progress being made that shares skyrocketed over 80% in the few days following the news. This is what can happen to severely beaten-down stocks. Even the smallest sliver of positive news can propel shares higher.
Ongoing operational improvements are just what Carvana needs. Couple this with the possibility of a bull market, and investors might want to take a chance on this high-risk, high-reward stock.
